June 1, 2007 at 8:00 AM ET
A few weeks ago, we shared the story of Rachel Poor, who faced a double-barreled 21st century nightmare when an identity thief stole her money and her bank piled on with penalty fees. In addition to losing thousands of dollars to the thief, Poor faced a maddening set of overdraft charges -- 22 to be exact -- while she tried to dig out of the hole her imposter put her in.
The column resonated with Red Tape readers -- 1,300 comments were left on the blog, a record. Many writers expressed bitterness and frustration toward their banks and described their own overdraft fee nightmares.
Well, help may be on the way. Two major studies are being conducted to examine bank bounced check practices -- one by the Federal Deposit Insurance Corporation and one by the General Accountability Office, Congress’ investigative arm. Federal legislation introduced by Rep. Carolyn Maloney, D-N.Y., would bar many current bank overdraft practices. And a congressional hearing is planned for later this summer to highlight abuses of the practice.
"Congress should help rein in the billions of dollars in hidden overdraft fees that bank customers are forced to shell out every year,” said Maloney, who chairs the House Subcommittee on Financial Institutions. “Hidden overdraft fees are unfair, and fairness is an essential component of a safe and sound banking system.”
Why do overdraft fees seem to generate so much ire? For starters, they often come as a surprise. That's the reason that this month's "Gotcha Room" explains how easy it is to incur an overdraft fee. Click here to watch the video.
Here’s the crux of the problem: Many people believe that if they ask an ATM for more money than they have in their account, the ATM will simply say "no." Not True! One upon a time, ATMs were good at rejection. Today, they’ll say “yes” to nearly anyone.
Just about anyone with a checking account in any national bank is automatically enrolled in something called "courtesy overdraft protection." The “courtesy,” it turns out, is that the banks will allow withdrawals that exceed balances and then tack on a hefty fee of about $35.
NOT JUST ONE OVERDRAFT FEE
And as Rachel Poor found out, often there are multiple charges. After an account “goes negative,” every account withdrawal -- by ATM, by debit card purchase, by online bill payment – incurs another fee. It’s easy to wrack up four or five of those in a weekend, or 22 in Rachel’s case.
Debit card purchases add to the confusion because banks allow debit card purchases even when accounts don't have enough money to cover the transaction. That profitable permissiveness can easily turn a $3 hamburger into a $38 hamburger.
No one knows exactly how much money banks are making this way, but there are some good guesses. Fees make up about one-third of bank revenue at this point, and overdraft fees make up a large chunk of that. The Center for Responsible Lending estimates that banks collected $10 billion in overdraft fees during 2005.
Judging from the number of people who wrote in after Rachel Poor's story, that estimate might be low.
Consumer advocates object to the fees on many levels. Chief among them -- using a debit card was supposed to be the healthy alternative to credit cards, which were designed to encourage people to spend money they don't have. Debit cards were supposed to prevent that bad buying habit, as purchases are withdrawn directly from checking accounts. At one point, it was impossible to spend more than you had with a debit card. But with "courtesy overdrafts," debit cards become a lot more like credit cards -- only worse. Not only can you overspend, but the loan you are given as a result is just about the most expensive loan out there. The effective annual percentage rate on debit card overdraft fees can be 1,000 percent. In most cases, consumers hovering near a zero balance and buying that $3 hamburger would be far better off taking out their credit cards, even if they are revolving users who pay interest immediately on the purchase.
SURPRISE! A $38 HAMBURGER
Making matters worse: Consumers rarely know when they are about to buy a $38 hamburger. It’s nearly always a surprise when the monthly billing statement comes.
It doesn’t have to be that way. A simple warning would be nice, something like the "foreign ATM $2 fee" warning we are all so familiar with. Something like this:
ATM: "I'll let you take out that $20 you don't really have, but it will cost you an extra $35. Are you sure you want to do that?"
You (turning to friend): Uh, Bill, can you spot me $20?
Implementing such a warning screen is one of the main provisions in Maloney's bill. Of course, banks aren't interested in adding the warning. Nessa Feddis, spokeswoman for the American Bankers Association, said it’s not technically possible. There are always outstanding checks or pending electronic transactions (such as scheduled Internet bill payments) which make real-time balance checks impractical, she said.
“There will always be the possibility of approving a transaction when there aren’t sufficient funds,” she said. “It’s consumers who are in the best position to know exactly what their balance is.”
Feddis also said consumers appreciate the convenience of overdraft protection, as they don’t face the hassle of rejected purchases at checkout counters. And in the case of bounced checks, the fees can actually save consumers money. In the past, a bounced check would incur two fees -- one from the bank and one from the merchant. Now the bank covers the check and charges only one overdraft fee, she said.
But that benefit of overdraft protection only applies in the case of bounced checks. Covering consumers’ debit purchases and then charging a $35 fee doesn’t save the consumer money compared to the days when the transaction would simply be declined.
Given the decline in popularity of checks, the majority of overdraft fees are now generated through debit transactions and other electronic transactions, the Center for Responsible Lending found in a recent study.
FED RULING BACKED BANKS
That's one reason banks fought -- and won -- in the last round of Washington D.C.-hand-wringing on the subject. Two years ago, the Federal Reserve issued new rules governing overdraft protection, but the rules have done little to help consumers. In fact, they may have made things worse. The Fed declared that overdraft fees were not a loan and thus not subject to Truth in Lending disclosure practices, which would include clear publication of those obscene annual percentage rates. Now, only banks that market courtesy overdraft protection service must explain the cost of the money. Banks that keep the service and the fees quiet only have to include small-print notices when you open your account.
Maloney's bill would change that, too, as it would redefine overdraft fees as loans.
Feddis argues that publishing those rates would only confuse consumers.
"People understand dollars. ...The rate would be misleading to consumers," she said. "It's not a loan, it's a service fee."
Whatever they are, clearly many consumers hate them. More important, many consumers are surprised by them, and that should never happen. ATMs should warn consumers before they overdraw their accounts -- something that is just as feasible as account balance checks, despite what banks say. And if warnings aren’t given, hamburger purchases should simply be declined when balances are below zero unless consumers actively ask for the protection.
RED TAPE WRESTLING STRATEGIES
Tell your bank you want to opt out of courtesy overdraft protection. While you’re at it, link your credit card or savings account to your checking account, which will provide you true overdraft protection for pennies on the dollar.
If your balance is low and you are using a debit card, tell the clerk you want to sign the receipt and not enter a PIN, says Gartner payment expert Avivah Litan. Signature-based debit transactions are processed a little bit more slowly than PIN transactions, so you’ll buy yourself a little time to deposit money and cover the withdrawal, she says.
Consumers who think the current system is unfair should write to the Federal Reserve and complain, and write to their congressional representatives asking them to support the "Consumer Overdraft Protection Fair Practices Act" introduced by Maloney.