Feb. 25, 2009 at 8:00 AM ET
Cheryl Clymer knew her luck was about to run out. For several weeks she'd been walking a tight rope on her checking account balance, paying bills at the very last moment and depositing checks as soon as possible. But last week, with the power company threatening to turn off her lights, she had to pay her $260 electric bill even though she knew that her car payment -- scheduled to be automatically withdrawn that same day -- would push her account into the red. There was a slim chance, she figured, that one of the payments wouldn't be debited right away, and the paycheck coming in two days would cover her, but she fully expected she would be hit with a $35 overdraft fee.
But when she checked on her account a few days later, her heart sank. She'd been hit with $185 in fees -- five separate $37 charges.
Clymer was victimized by an extreme form of what's called "high-low" check processing, a term that's becoming better known as more U.S. consumers find themselves living close to that checking account edge.
Clymer knows her neighbors are having similar struggles – the unemployment rate is more than 10 percent in her hometown of Toledo, Ohio. While she looked over her bank statement in disbelief, she couldn't help but think about the billions of dollars in taxpayer money being spent to prop up banks right now.
"Don't they know I have buy gas to go work and food to eat?" she said. "Don't they have any idea what they are doing when people are on the verge of losing homes and getting utilities shut off (and) they gouge their customers like this?"
Here's what Clymer said happened to her account. The weekend before the car payment was due, she had made four small debit card withdrawals over a three-day weekend. But they were not deducted immediately. In fact, the bank "saved" these charges, and only debited her account after she paid the power bill. That meant all those charges hit after her account was in the red, and each incurred a $37 charge.
The way Clymer sees it, her account was in the black when those weekend withdrawals occurred, so she shouldn't have to pay overdraft fees on them.
"I had the money on the day my four debits were done. ... Why am I penalized for five transactions instead of the one transaction that I realized was not going to clear?" she said. "Why am I the victim of their whims of their timing schedule? I am so angry that I am shaking."
High-low processing has been a sore point with consumers for years. If several transactions hit on the same day, banks will debit the largest one first, then proceed downward. This creates situations like the one that Clymers was caught up in: If her small transactions were processed first, only one would have occurred while her account was in the red, triggering one overdraft fee. By processing the largest first, the bank was able to charge five separate fees.
An average of $368 every year
Most banks offer "free" checking accounts, but as Clymer discovered, these free accounts can be expensive. Last year banks collected a stunning $37 billion in overdraft fees, according to a study by bank consulting firm Bretton-Woods Inc. That works out to $368 per account holder every year.
Bankrate.com has conducted an annual survey of bank overdraft fees for nearly 20 years. Only twice during the span have overdraft fees not risen; it goes without saying that they've never shrunk. Fee income is an essential part of banks' revenue now, and at some institutions it has replaced interest margin earnings as the main source of income. In fact, fee income doubled from 2004 to 2008, and the number of individual overdraft items more than doubled -- from 619 million to 1.3 billion -- over the four-year span.
Consumers who want to save money on banking need to think like a financial institution. You have two sources of trouble: fees and opportunity costs. Let's start with fees.
Cut out the fees
Given the wide availability of free checking accounts, the majority of bank fees that consumers pay are punitive. The Bretten-Woods survey indicates about 80 percent of all bank fees are overdraft fees. That makes overdraft fees avoidable in most cases, which is how the banking industry defends them.
"Only (account holders) know what checks they have written, automatic payments they have authorized and debit card transactions they have approved. Simply put, consumers are in control of their finances and can avoid overdraft fees," Nessa Feddis, counsel for the American Bankers Association, said at a congressional hearing on bank fees last year.
But banks have designed their fee structures to force consumers into a game of account balance roulette. Remember, punitive fees are critical to banks' bottom line now – their very survival depends on winning this game. So bankers spend endless hours trying to concoct new rules and booby traps to trip consumers. And when they do slip up, the banks exact a pound of flesh.
It's reasonable for banks to charge fees for overdrafts. But tales like Clymer's are the rule rather than the exception, meaning the punishment often doesn't fit the crime. The fact that banks now make their living by punishing their customers should tell you all you need to know about this industry.
Here's how to avoid their traps.
For years, consumer advocates have advised account holders that the best way to avoid "courtesy" overdraft fees is by linking savings or credit cards with their checking accounts. If an overdraft occurs, consumers with linked accounts will essentially be paying the fee with their own money.
While linked accounts are still a good option, banks have caught on to the fact that consumers are wising up and are reacting accordingly. Citibank, for example, last year initiated a $10 fee for each linked transfer – a steep charge for merely transferring consumers' money from one account to another.
It's important to know all the various ways that overdrafts can occur, particularly if you are new to living on the edge of a bank account. Many consumers don't realize that they can trigger an overdraft by making a debit card purchase or withdrawing money from an ATM. Once upon a time, banks would reject transactions or withdrawals that exceeded balances, but now most banks will approve negative balance transactions and charge fees. To avoid them, tell your bank that you decline "courtesy" overdraft protection.
Of course, that's no help if you're in Clymer's situation. Consumers who require an overdraft to get through the month should look hard for other alternatives. Payday loans and credit card cash advances are a terrible option for paying monthly bills, but in Clymer's case they would have been cheaper. If you consider that an overdraft charge is really a fee for a short-term loan, the effective interest rate can be nearly 1,000 percent.
Consumers also should be aware that the bank is likely to orchestrate the order of transactions in its favor. Banks will always cash the largest check or debit the largest transaction first, enabling them to layer on the maximum number of overdraft fees.
For this reason, consumers should avoid using a debit card for purchases. A credit card is a better choice for those close to the edge. Paying in cash is still best, but it's a good idea to minimize cash withdrawals by planning ahead.
It's also important to recognize that your banks' fee structure may be radically changed if it's been absorbed by another bank recently as part of the massive industry consolidation under way. As surviving banks swallow failing ones, watch the mail carefully for notifications of changes to fee policies. You can bet the news won't be good. Larger banks almost always charge higher fees than smaller banks.
A recent study by Moebs $ervices found that banks with more than $20 billion in assets charged an average of $33 per overdraft, while smaller banks with under $100 million in assets charged an average of $24.
The bleaker things get for banks, the more aggressive you should expect them to be in assessing fees. Anecdotally, readers report that fee waivers are much harder to obtain now. Still, if you are hit with cascading fees, visit your local branch and plead for leniency. Even better, plan ahead for such an occurrence. Make sure to visit your local bank branch from time to time and say a friendly hello to the bank manager or receptionist. It's always easier to ask for help from someone who knows you.
A proposal to reign in overdraft fees was considered by banking regulators when they issued new credit card rules earlier this year, but it was set aside. Legislation working its way through Congress right now, known as the Credit Cardholders Bill of Rights, includes provisions that would limit some of these overdraft practices. Call your congressional representative and voice your support for the law if you'd like to see some change.
Many consumers don't think much about opportunity cost, which in this case might be defined as what you miss out on while you're parking your money in the equivalent of a mattress every month. Interest rates at most banks now must be measured with an electron microscope. Returns of less than 0.1 percent annually are typical. Obviously, that means interest-bearing checking accounts aren't worth the trouble, particularly if they come with a high minimum balance. Those accounts force you to fork over $1,000 to $3,000 or more for the bank to use. You can't touch the money and, once again, if you slip up even for one day, the penalty is severe. Using such an account places you at risk for a $12 monthly service charge when some rainy day arrives. Dump that risk and sign up for the cheapest no-interest, lowest minimum balance account your bank offers.
You'll probably have to badger a teller to get instructions on how to sign up for the no-frills package. But all banks have them.
After you sign up, pay close attention. Banks have been known to end such basic options and "upgrade" accounts without much warning. Watch for that.
Your 'staging' account
Many banks offer fee-free checking to anyone who signs up for direct deposit. That's often the best way to get free checking. But this account should be used only for temporarily parking your salary and to pay the big monthly bills, like your mortgage or car payments. I call this the "staging" account.
Consumers who use their checking account for everything inevitably run into trouble. It's too hard for most people to keep a firm grasp on their balance while buying $4.50 lattes every day, making electronic payments, and depositing small checks. Bankers call this "velocity," and most people have too much of it. That's a recipe for disaster, and it almost certainly costs you interest income.
If you really must use a debit card for purchases, set up a second account – or an "allowance" account -- and transfer money into that each month. Then use a debit card to draw money on that. This keeps your main life balance sheet clean and simple. That's the best way to keep track of how you're doing every month, and how at risk you are for an overdraft charge. No consumers' primary checking account should be littered with 30, 40 or 50 transactions every month.
Next, make sure your leftover money is working for you. There are many ways to accomplish this. If you haven't yet considered an Internet-based savings account like ING Direct or HSBC Direct, you're really missing the boat. Rates on these accounts have shrunk too, in concert with Federal Reserve rate cuts, but they're still above 2 percent. They are easily linked to your primary, or staging account. And they are still FDIC insured. Two percent guaranteed should sound pretty appetizing when you think about everything else going on in our economy. If you keep an average balance of $5,000 in an interest-deprived checking account, you're throwing away more than $100 a year by not opening one of these accounts. And when the coming wave of inflation arrives, you'll be in position to earn much more.
Much the same can be accomplished by linking your primary checking account to a money market account at another financial institution or your brokerage, but keep an eye on those interest rates. Many money market interest rates have shrunk to anemic levels too.
Have you been hit by huge bank fees? Or do you have an idea for saving money on bank accounts? Leave your comment below or visit Newsvine and join the Red Tape Raiders.