Advertiser Disclosure

Eliminating Fees

How Overdraft Fees Silently Rip You Off

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

How Overdraft Fees Silently Rip You Off

It’s Thursday, the day before payday. You only have $50 left in checking and have forgotten that your gym membership of $70 will be automatically debited from your account today. Normally, you’d transfer a little bit out of savings to cover the cost if you needed to, but you didn’t do it in time. The bank approved your gym’s charge and now your balance is negative $20.

Whoops, you’ve gone overdraft.

33% of Americans have gone overdraft in the last year

In a recent survey, MagnifyMoney discovered 33% of Americans have gone overdraft in the last year. If you haven’t yet, it is bound to happen at some point. Either we make a mistake, or we actually run out of money.

Going overdraft in the United States – even accidentally – is one of the most expensive ways to borrow money in the world.

  • Banks charge effective APRs > 1,000% – making them worse than payday lenders

  • Banks have purposefully made the system obscenely complex.

  • Banks regularly re-order transactions in the background, increasing the fees you pay and stacking the deck against you

The U.S. always wants to be #1…

Unfortunately, overdrafts in the US are the most expensive form of short-term borrowing I have seen in the world.  Yes – it is more expensive to borrow here than in the UK, Russia or Mexico! Banks made $32 billion last year in overdraft fees alone.  And, in our survey, borrowing $100 for 7 days could cost up to $300 in fees!

How do fees work?

In the example of the gym membership, the bank has 2 choices: approve the transaction or decline the transaction.

If they approve the transaction, then you go overdraft and will be charged an overdraft fee. The average fee is about $35 per incident.  You can be charged multiple times a day.  One of the worst examples is Citizens Bank, which charges $37 per incident, up to a shocking 7 incidents per day. I’ll save you whipping out the calculator, that’s $259 in fees for a single day!

When your account is overdrawn, the balance is negative. You have to bring the balance positive (by putting money into the account), or else you will be charged an extended overdraft fee.

At Bank of America, you would be charged another $35 if the account is negative for 5 days. And remember: you have to cover both the amount you borrowed and the fee.  In the case of the gym membership – you would have to pay the $20 you borrowed and the $35 fee in 5 days, otherwise you are charged another $35!

If the bank decides to decline the transaction, you still get charged a fee.  This fee is called an NSF fee aka non-sufficient-funds fee.  And, guess what?  The fee is still a shocking $35 per incident.

So: you are charged $35 if it is approved or declined.

Doesn’t the bank also mess with how my transactions are posted?

In a normal world, transactions that take place at 8AM will be deducted from your checking account at 8AM.  Unfortunately, the rules are stacked against you.  Rather than posting the transactions when they actually happened, a lot of banks post transactions when they wish they would have happened.

Nearly 50% of banks use what is called “high to low processing.”  They take all of your transactions from the day, and deduct them from your account from highest amount to lowest amount (and they do this at the end of the day).  That means you will go overdraft sooner, and you will pay more fees.

Imagine you have a balance of $50.  You have 2 transactions: a morning trip to Starbucks for $5, and then dinner for $55.  If the transactions were posted in order, then you would only have one overdraft transaction: the dinner for $55.

If the transactions were posted from high to low (and not in the order they happen), then you would have 2 overdraft transactions!  At an average bank, that would increase the fee from $35 to $70!

And that is perfectly legal.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Nick Clements
Nick Clements |

Nick Clements is a writer at MagnifyMoney. You can email Nick at [email protected]

Advertiser Disclosure

Eliminating Fees

Calling Out the Banks: Fix the Overdraft Market

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

solutionsforbrokenoverdraft-lg

 

Overdraft protection sounds like a program that would, I don’t know, protect you? Instead it helps lessen the fees but still gives banks the opportunity to charge you $10 to $12 (if not more) for transferring your money to cover an overdraft.

Understand what you’re up against

When I worked in banking, we would look at certain warning signals.  If a product is excessively complex and extracts revenue that is exponentially higher than the cost of providing the service, then something is wrong.

I believe the overdraft market in the US is fundamentally broken, and has morphed into the worst type of predatory lending.

I have a really simple solution, and banks all over the world are already doing this.

  • Declining a transaction costs banks fractions of a cent, so charging consumers a $35 decline fee is obscene.  The most they should charge is a few dollars. Some new entrants charge nothing at all – and they are right to do so.

  • An overdraft is a short-term loan.  Lets stop talking about fees, and start talking about interest rates

    • Checking accounts should have a disclosed overdraft limit.  In other words, you should know that you can go up to $500 overdraft

    • The bank should charge a fair interest rate for the money you borrow – and only for the days that you borrow the money

Some banks are reasonable when it comes to overdraft

First Direct, one of the most popular banks in the UK, offers the following:

  • Free overdraft protection up to $250

  • A line of credit above $250 (the better your credit score, the higher the available line).  The interest rate is about 15%.  You don’t pay a fee-only interest for the days that you use the credit line.  So, if you borrow $100 for 7 days, you would pay about $0.29.

  • If you use your entire overdraft line, and the bank declines additional transaction, you pay nothing.

Banks should make money.  This is not a charity.  But they should offer transparent pricing that is easy to understand and compare.  And the profit should be in line with the cost of providing the service.

Consumers should be able to compare and choose the best option – just like any other consumer product. Fortunately, we’re helping you do just that.

Banks that respect you and your money

Consider switching to an internet-only bank. I have made the switch.

If you have a few instances of going overdraft because of a simple mistake, then consider Ally Bank.  You get one of the best interest rates on the market for your savings account. And, if you go overdraft, Ally DOES NOT CHARGE YOU for transferring money from your savings account to your checking account.  Why you ask? Because, it doesn’t cost them anything to do it!

If you go overdraft because you need the money, then Capital One 360 might be right for you. This is the old ING Direct.  They act a lot like First Direct of the UK: no overdraft transfer fee, a line of credit, and you only pay interest for the days that you are overdraft.

If you never want to go overdraft again – and wish the bank would just decline your transaction and not charge you a fee, then look into Bluebird or Serve (both from Amex). Bluebird is in partnership with Wal-Mart.  You can never go overdraft, and you will never be charged an NSF fee.

Even if you love brick-and-mortar bank branches, do the math to see if switching to an internet-only bank could save you a substantial amount of money in fees – and don’t forget the cost of gas!

Want to know more about Internet banking? Check out this article.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Nick Clements
Nick Clements |

Nick Clements is a writer at MagnifyMoney. You can email Nick at [email protected]