By Herb Weisbaum ConsumerMan contributor
updated 3/26/2009 8:08:17 AM ET 2009-03-26T12:08:17

Would you pay $38 for a cup of coffee? Clifford Phillips of Spokane, Wash., did. He used his debit card to pay for a latte, not knowing there wasn’t enough money in his checking account to cover it. The bank could have declined the transaction for insufficient funds. Instead it approved the electronic payment and dinged his account with a $34 overdraft fee.

At most banks and some credit unions, most checking accounts are now automatically enrolled – as a customer service – in an overdraft protection program. The financial institution lets you spend more than you have, loans you the difference (up to a certain amount) and hits you with a hefty fee.

Phillips didn’t know his account had this overdraft feature and doesn’t want it. He tells me he prefers “the embarrassment of having the transaction denied” to being socked with a $34 fee. But the bank won’t let him cancel.

“That’s not customer service, that’s exploitation,” he says. “I should have the right to say I don’t want it.”

Consumer groups hate these automatic bounce protection programs. They refer to them as overdraft loan programs because that’s what’s really going on here. The banks are giving you a short-term loan to cover the overdraft at a sky-high interest rate.

“The big banks are making a ton of money on this, so are some credit unions,” says Ed Mierzwinksi, consumer program director at U.S. PIRG. “This overpriced rip-off service makes no sense to anyone but the banks.”

Jean Ann Fox, director of consumer protection at the Consumer Federation of America, just laughed when I told her bankers call automatic overdraft protection a “customer service.” She says banks are “taking advantage of customers” by letting them overdraw and then slapping them with “gotcha fees” for each overdraft that’s allowed.

The banking industry sees it differently. Nessa Feddis with the American Bankers Association tells me customers appreciate the service “because they want their bills paid” and she insists most banks allow customers to opt-out.  The ABA also points out that these fees are avoidable. “If people don’t want to pay these overdraft charges they can keep track of their transactions,” Feddis says.

The Fed considers new rules
The Federal Reserve Board has proposed rules for how banks should handle their overdraft service for ATM withdrawals and debit card transactions. There are two options on the table: opt-in and opt-out.

Opt-in would truly reform bank practices. It would require them to get your permission in writing before you could be enrolled in the overdraft program. Opt-out keeps things the way they are. Banks could continue to sign up customers without their express consent, but they would be required to let anyone opt-out if they didn’t want the costly protection.

It’s no surprise the banking industry supports the opt-out proposal while consumer groups want the rule that requires customers to opt-in. The American Bankers Association says not only is automatic enrollment better for people; it’s what people want. “Customers have demonstrated this is their overwhelming preference” says the ABA’s Feddis.

Consumers Union claims it’s just the opposite. In a letter to the Fed, it cites a poll by Consumer Reports National Research Center. The poll found “an overwhelming number of consumers want a real choice when it comes to overdraft programs.” Two-thirds said they prefer to expressly authorize overdraft coverage.

The survey found many people do not understand how automatic overdraft programs work. Consumer Reports found that 39 percent of the people thought their bank would either deny a debit transaction or allow it to process without charging a fee if it would overdraw the account. Nearly half of those polled (48 percent) thought their ATM card would not work if they tried to withdraw more money than was in their account.

“If banks believe the overdraft programs are truly beneficial, then they should be required to persuade their customers to sign up before they can charge them such high fees,” writes Consumers Union lawyer Zeichner Bowne.

Congress tackles overdraft fees
Last week Congresswoman Carolyn Maloney (D-NY), a senior member of the House Financial Services Committee, introduced the Consumer Overdraft Protection Fair Practices Act. This bill (H.R. 1465) would require banks to give customers a warning that their withdrawal from an ATM or purchase with a debit card is about to trigger an overdraft. The customer would then have the option to stop the transaction or accept the overdraft service and the associated fee.

Rep. Maloney says this legislation will give people greater control of their finances. “Giving consumers notice and choice related to the fees and programs they are enrolled in should be a basic right,” she says.

Bankers say they’d have to modify their networks to make this happen which could reduce the availability of overdraft protection for customers who want it.

If passed, this bill would also require banks to change the way they process checks, debit card transactions and other withdrawals from a checking account. Many banks automatically process daily debits from largest to smallest. The banks say this is another customer service. Because the bigger amount is more likely to be a mortgage, rent or other important payment, they think customers would want those to go through and have smaller debits bounce.

Consumer advocates claim banks pay the largest amount first because it increases the likelihood of an overdraft or multiple overdrafts, which results in more penalty fees.  A national poll for Consumer Federation of America found that 81 percent of surveyed consumers want banks to process payments either in the order presented or smallest first.

The Maloney bill would prohibit banks from manipulating the sequence in which checks and other debits are posted if it causes more overdrafts and maximizes fees.

By the way, Rep. Maloney also authored the Credit Cardholders Bill of Rights , which is working its way through Congress.

My two cents
It’s one thing to overdraw your account by writing a check. It’s quite another when an overdraft takes place electronically – using a debit card or ATM. In these situations, the bank knows if you are going to overdraw the account and could either stop the transaction or give you the option to pay the penalty and proceed. In this case, customer choice is customer service. 

The banks have lobbied hard for the status quo and for good reason; they’re making a ton of money. Consumers Union figures the nation’s banks collected about $7.8 billion last year in overdraft fees related to debit cards and ATM withdrawals.

According to the FDIC, the average overdraft triggered by ATM and debit card transactions is $17. The median fee for each overdraft is $27.

Consumer groups are doing their best, but the regulators need to hear from you. Time is running out. The comment period ends next Monday, March 30. Contact the Federal Reserve right now and let the Board know you want the opt-in rule. It’s just silly to make you cancel a service you didn’t ask for. If bankers are so sure customers want this high-priced overdraft protection they don’t have anything to worry about.

The Center for Responsible Lending web site has more information on bank overdraft fees and an easy way to comment to the Fed.

To comment directly to the Fed send an e-mail here. The subject line MUST include “Docket No. R-1343.”

Or fax your comments to 202-452-3819.

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