Overdraft protection is now a service you must opt-in to, thanks to the Dodd-Frank Act. So it’s worth considering exactly what you get for that $30-$35 a shot you pay to avoid bouncing a check. One useful way to think about overdraft protection is as a last-resort line of credit. Overdrawing your checking account is, essentially, asking your bank for a small short-term loan.

Orin Zebest/flickr source

So, if overdraft protection is a loan, then what’s the annual percentage rate (APR)? How does it stack up against other forms of credit?

Not so well.

Overdraft compares “very unfavorably to payday loans when you calculate the effective [APR],”  Arjan Schutte, managing partner of Core Innovation Capital, a venture capital firm that funds companies that bring banking services to the underbanked, wrote in an article on BAI.

Overdraft APR: unattractive if you do the math

We asked Schutte to elaborate on his thoughts for MyBankTracker.

“Overdraft APR is a highly imperfect science,” he said in an email. “But [it] can easily be 1000-3000%, assuming common [overdraft] fees of $35.” Most people overdraw less than $20, he explained, and the repayment period is at the end of the month — or two weeks on average.

Even a loan shark wouldn’t charge you $55 two weeks after you borrowed $20. According to an old Sacramento News & Review story, the Chicago Outfit, an organized crime family that still operates in some form in the Midwest, used to charge 260% APR on their loans. Mafia debt collectors found that baseball bats were more effective than phone calls, and perhaps this priced down their risk considerably.

In any event, overdraft protection simply is not a good deal. Perhaps that is why the Consumer Financial Protection Bureau is investigating the practice, as The Hill reported earlier this week. Richard Cordray expressed concern that overdraft policies and fees are intentionally obfuscated by banks, prompting the investigation. The Hill makes mention of a potential “penalty fee box” which would “detail how much a person has paid out in overdraft fees, along with the amount overdrawn.”

It ought to calculate the effective APR of these loans, because that’s what really highlights how exorbitant the fees are.

Better options

People have other options even if they can’t get or don’t want to use credit cards. They may not be good options … but they beat overdraft protection.

Schutte points out in his story for BAI that both U.S. Bank and Wells Fargo offer cash advance products that “cost basically the same as payday loans.”

U.S. Bank’s service is called Checking Account Advance, and it is offered for checking customers who use direct deposit. Customers can borrow anywhere from $20 to $500, and they pay $2 for every $20 that they borrow, to be paid in full within 35 days. That annualizes to about 100% APR, which certainly isn’t attractive, but it’s better than overdraft protection by an order of magnitude, and it’s definitely better than the rate you’d get from the Chicago Outfit.

Wells Fargo offers something called the Direct Deposit Advance, which is similar to U.S. Bank’s product but it has slightly more attractive terms. It is also only available for checking customers who use direct deposit. Users can borrow, in increments of $20, up to $500 or half the amount (rounded up to the nearest $100) of monthly direct deposit income. Wells Fargo charges $1.50 per $20 borrowed, and loans must be repaid within 35 days. Annualized, this is about 75% APR, which isn’t attractive on its own, but better than the alternatives.

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