If you're one of the 40 million people who paid an overdraft fee last year, you won't be surprised to hear that it's now a $33 billion industry.
In fact, expensive overdraft protection fees have become a "frequent and harmful" practice throughout the banking industry, according to two new reports from the Pew Charitable Trusts.
The studies found that smaller banks now tend to have prices and practices similar to large financial institutions.
"Too many banks, both large and small, charge high and multiple fees and engage in practices that are unfair," said Nick Bourke, director of Pew's consumer finance project.
"Our research shows that 40 million people throughout the country paid an overdraft or NSF [nonsufficient funds] fee last year and that's not good for anyone — and most of the people (68 percent) would rather have their transaction declined than pay that steep overdraft fee," he told NBC News.
Pew reviewed disclosures from the 50 largest banks (based on deposits) as well as 45 smaller banks. The study notes that these 45 institutions do not constitute a representative sample, but they do highlight practices common at smaller banks.
The study found that:
- Most of the large U.S. banks charge between $35 and $38 dollars for each overdraft
- Most small banks charge between $28 and $36 (the median fee was $32)
- About half the large banks and one-third of the small banks studied charge an additional fee if a customer does not repay the overdrawn balance — including the original fee — within a specified number of days. Most of these fees — $6 median for small banks and $20 median for large banks — can be charged repeatedly for the same overdraft until the balance due is repaid.
The nation's bankers consider overdraft protection a popular service and they insist many of their customers would rather pay a fee than bounce a check.
"Research consistently shows that people value overdraft protection, particularly those who have experience using it," said Virginia O'Neill, a senior vice president at the American Bankers Association. "We surveyed people who had used overdraft protection six or more times in the prior year and found that they understood it, valued it and made a rational choice to use it over alternatives."
The ABA says customers have various tools to manage their accounts and avoid overdrawing, including low-balance text alerts and the ability to monitor account balances online or by phone. O'Neill told NBC News that overdrafts caused by using a debit card can be eliminated if customers decline to sign up for overdraft protection. Without debit card overdraft protection, a transaction will be declined — with no penalty — when there's not enough money in the account to cover it.
A Big Money Maker
Overdraft fees have become a significant source of revenue for many financial institutions. Banks, thrifts and credit unions earned $32.5 billion in overdraft revenue last year, an increase of two percent from 2015, according to the economic research firm Moebs Services. The nearly $700 million in added revenue was the biggest yearly overdraft fee increase in five years.
And the trend continues. A new Moebs study released in mid-December shows that for the first three quarters of 2016, overdraft revenue hit $32.9 billion. Credit unions earned $6.1 billion in overdraft fees during this period. That's an increase of 3.4 percent from 2015, and the highest amount of overdraft revenue in the history of credit unions, the report said.
"High and excessive overdraft fees have become an unfair burden for financially vulnerable consumers," Pew's Bourke told NBC News. "Consumers need to be responsible, but it's not responsible for banks and credit unions to pile on overdraft fees in a way that drives people out of the banking system."
The recent boom in prepaid debit card sales has been fueled, in part, by the demand for an overdraft-free alternative to checking accounts. Americans loaded nearly $65 billion onto general purpose "reloadable" prepaid cards in 2012, according to the Consumer Financial Protection Bureau. That's expected to grow to $112 billion by 2018.
The way a financial institution processes transactions can result in more overdraft fees for some customers. Reordering daily transactions from highest to lowest dollar amount can reduce the account balance more quickly, causing more overdrafts. Here's an example of how reordering can be costly:
Let's say you had $100 in your account and you write three checks that day: a $10 check at the dry cleaner, $10 at the convenience store and $105 at the auto repair shop. If the checks are processed in the order written, the first two checks would clear, but the third would cause an overdraft and you'd get hit with one fee.
But if the bank processes the checks from highest to lowest, the $105 check will overdraw the account, leaving no money to cover the other two $10 checks when they are processed. The result of reordering: three overdraft fees instead of just one.
Bankers say they do this to protect their customers. The larger checks tend to be the most important ones, such as the rent or mortgage or car payment. Those are the ones people want to go through, they say, not the small check at the nail salon.
The Pew report noted that transaction reordering is not as prevalent as it has been, but about half the largest banks in the country still do it. It's less common at smaller banks.
A Call for Change
Pew wants federal regulators to revise the rules for overdraft programs. Their suggestions include:
- Make overdraft penalty fees "reasonable and proportional" to either the financial institution's costs in providing the overdraft loan or to the overdraft amount
- Limit financial institutions to six overdraft charges in a 12-month period and limit fees to one per negative balance incident
- Prohibit financial institutions from reordering transactions to maximize overdraft fees. Pew wants transactions to be processed either chronologically or from low to high dollar amount.
Bankers say new regulations are not needed and could actually hurt people.
"Restricting access to overdraft services to meet an emergency or manage an income disruption would cause greater harm to consumers," said the ABA's Virginia O'Neill. "Things happen in life and a lot of people don't have the savings to meet it."
A significant number of overdrafts are caused by small debit card transactions. We've all heard about the $35 cup of coffee. In fact, the majority of debit card overdraft fees are incurred on transactions of $24 or less, according to a 2014 study by the Consumer Financial Protection Bureau.
This can only happen when you "opt in" or agree to overdraft protection for debit card and ATM transactions. Decline the coverage and you can't overdraw with your debit card.
Studies have shown that many Americans signed up for this protection without realizing it — or assuming it would prevent fees.
Not sure where you stand? Contact your bank or credit union and ask them this simple question: What happens if I use my debit card and the transaction would overdraw my account? Is the transaction declined or is it approved and I get charged a fee?
Even if you agreed to have overdraft protection, you can decline the coverage at any time and avoid those fees.