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Updated on Friday, May 1, 2015
This week, the Consumer Financial Protection Bureau (“CFPB”) fined Regions Bank $7.5 million for unlawful overdraft practices. In addition to the fine, Regions Bank has refunded approximately $49 million of fees to customers. Regions Bank is based in Alabama and has more than $119 billion in assets, making it one of the largest banks in the country.
Regions Bank was fined because it failed to receive the necessary opt-in from consumers, delayed fixing the problem for a year and mis-represented certain fees to its consumers. The CFPB has been looking closely at the overdraft practices of banks. Director Cordray has made it clear that he is not a fan of the way banks treat overdrafts, and bigger reforms are expected later this year. In the interim, we can expect more fines of banks that are violating existing rules and guidelines.
Regions Bank earned $218 million during the first three months of 2015. The CFPB fine does not represent a significant portion of the bank’s earnings.
Abusive Overdraft Practices
Overdrafts in the United States are incredibly expensive for consumers, and unimaginably lucrative for banks. During 2014, banks generated over $30 billion of overdraft fees. When you look at how banks charge overdraft fees, you can see how easy it is for banks to generate so much revenue.
If you make a transaction in your checking account without having sufficient funds in your account to cover the transaction, you are at risk of being charged an overdraft fee. Imagine you have $100 in your bank account, and you try to write a check for $120. The bank has two choices: it can approve the transaction, or decline the transaction. If the bank declines the transaction, it will charge a non-sufficient funds (“NSF”) fee. The average NSF fee is $35. If the bank approves the transaction, it will allow the account balance to go negative. In effect, the bank gives you a loan. Banks charge, on average, $35 for an approved overdraft. So, you will pay $35 if you are approved, and $35 if you are declined.
Even worse, most banks have an extended overdraft fee. For example, Bank of America will charge an additional $35 if you do not bring your balance positive within 5 business days. Some banks even have a per day charge.
Some banks offer “overdraft protection.” That means you can link your checking account to a savings account or credit card. If you spend money that is not available in your checking account, the bank will sweep the money from the linked savings or checking account. However, most banks will charge a transfer fee, which averages $10. Given that most savings accounts only pay 0.01%, you would need to have $100,000 in your savings account in order to earn $10 in one year.
Even worse, if you link your credit card for overdraft protection, the sweep will be treated as a cash advance on your credit card. In most cases, that means you would be subject to an additional cash advance fee and interest would stat accumulating immediately at high double-digit rates.
As if the overdraft process wasn’t complicated enough, many banks reorder transactions to increase the overdraft fees. According to Pew, nearly 50% of banks engage in high-to-low transaction processing. Imagine you have a balance of $100. You make a purchase at 9AM for $10 (your new balance is $90). At 10AM you make another purchase for $10 (and your new balance is now $80). And then at 1PM you make a purchase for $100. The last transaction would cause you to go overdraft, resulting in a $35 charge.
50% of banks would reorder the charges, from highest to lowest. In this example, they would process the $100 transaction first, reducing your balance to $0. The other two charges would each cause the account to go overdraft. As a result, your fee would be $70 instead of $35. And that is all perfectly legal.
You do have certain rights. You can opt out of overdraft protection for ATM and debit card transactions. That means that if you use your debit card to make a purchase, and there is not sufficient money in the account, the transaction would be declined and you would not have to pay an overdraft or NSF fee.
However, you cannot protect yourself against checks and other electronic (bill pay) or recurring transactions.
Are There Cheaper Options?
Overdrafts can be incredibly expensive. The best way to avoid high cost overdraft protection fees is to consider an internet-only, branch-free bank. Many of the new start-up banks charge no overdraft fees and offer free overdraft protection from linked savings accounts. You can see some of these new providers here.
If you do not want to switch banks, you should consider opting out of overdraft protection, which will protect you from high fees on debit and ATM charges. You should consider linking your savings account or credit card, because the charges would still be less than standard overdraft fees. Finally, you should consider taking advantage of balance alerts to ensure that you are on top of your balance.
However, many people go overdraft because they have a short-term borrowing need. You should consider opening a low interest rate line of credit with your local credit union, or a personal loan from a marketplace lender. Credit unions and marketplace lenders offer significantly lower interest rates.