Overdraft Protection Is More Dangerous Than It Sounds

Such fees are billed as a service to consumers, but they do a lot of harm to the very people they purport to help.

Americans pay nearly $14 billion in overdraft fees every year, according to the Center for Responsible Lending. It’s no surprise then that these fees —which are often sold to consumers as a protective measure against failed transactions when there’s not enough money in an account—are a big contributor to financial insecurity, especially for low-income Americans, many consumer advocates believe. And despite efforts from regulators and industry watchdogs over the past several years to decrease recurring fees, dubious overdraft operations continue to flourish at many banks.

On Tuesday, the Pew Charitable Trust released new research about overdraft practices at banks around the country. When looking at the 50 largest banks (by domestic deposits), the study found that most charged fees of at least $35 each time a bank customer drew from an account that didn’t have enough money in it. And most of these banks allow for several overdraft fees per day. Around 40 percent of these large banks also explicitly allowed for what’s known as “transaction reordering,” when banks prioritize withdrawals from largest to smallest, increasing the chance that an account holder will hit a negative balance within a 24-hour period and incur several overdraft fees as they pull themselves further into the red.

Here’s one example from the CFPB complaint database about how reordering can impact overdraft fees:

I was aware of the low balance, but all transactions were processed. I was going to deposit money the next day. Overnight, BOA rearranged all transactions charging me 5 overdrafts ... Before they have waived the charges. Now they are insulting me for not keeping a straight balance. I do, but they keep rearranging transactions, so I keep falling in a hole and they take a chunk of my paycheck which comes direct deposit  … This is not the first time. XXXX dollar fee for a XXXX transaction that they caused by rearranging transactions? I will not allow them to take anymore money from my paycheck and child support. I work too hard. I have been with BOA for 26 years. They are stealing customers ' money now. I want and need my five overdraft fees removed. That was until XX/XX/XXXX and any after that, then I will deposit money and close my account. Thank you.

(The CFPB crosses out specific dollar amounts and days in order to protect sensitive information.)

High fees associated with basic checking-account services are often thought of as a problem of very large financial institutions, which many people view as impersonal and unforgiving. But according to Pew’s research, many small banks have the same shortcomings when it comes to overdraft. The study looked at 45 small banks (defined as those with between 360 million and 1 billion in deposits, and fewer than 30 branches) and found that 42 of them offer standard overdraft protection plans—which include the ability to overdraw at an ATM or during a debit purchase—while all 45 allow for some form of overdrawing on one’s account. (Pew is clear that these 45 banks may not be representative of all small banks.) Only two of these banks clearly state that they allow for transaction reordering, while the other 43 don’t explain how they order transactions in the event of an overdraft. And all of the banks allow for at least $90 worth of overdraft fees (which can occur from actively overdrawing or passively overdrawing via scheduled payments) per day.

Perhaps the most unsettling finding in the study—and many others—has been that despite rules that prevent banks from automatically enrolling account holders in overdraft, most consumers aren’t really sure whether or not they have the service. If they do, many don’t know what types of transactions trigger the fees, how high the fees are, or how many fees they can incur. Most customers say that they would prefer for a transaction to be denied rather than overdrawing on their account and being slammed with fees later.

“The prevalence of fee-based overdraft programs at both large and small banks underscores the need for new policies to prevent ‘courtesy’ overdraft programs from being costly and unsustainable forms of short-term credit for many financially vulnerable consumers,” said Nick Bourke, director of Pew’s consumer finance project. “Regulators should set reasonable limits on overdraft fees and help banks create new small-credit options for those who want them.”

Researchers from Pew say that some straight-forward fixes, such as clearer overdraft disclosures, and better options for opting out of such protection could help consumers. Lowering caps on daily overdraft allowances could prevent racking up large amounts of debt, while preventing the practice of transaction reordering—or at least being transparent about it—could help customers with low balances avoid overdrafting in the first place.

But it may be hard to convince the financial industry to implement those fixes, after all—a CFPB study found that overdraft makes up a significant share of total fee revenue at many banks. And some consumers may worry that the inability to overdraw on an account means that critical bills or expenses might be denied or delayed due to insufficient funds, leaving them in a bind. An option that banks may be on board with involves replacing current forms of overdraft with a short-term, small-dollar overdraft-loan option. This would allow consumers to opt in to a program where they would be given a loan for any overdrawn portions of their account. Banks would receive interest, but for consumers, payments would be less aggressive and immediate than current overdraft fees. These loan programs would also be subject to credit and lending best practices, such as ability-to-repay rules.

Overdraft coverage may seem at best like a convenient way to avoid embarrassment when sending a check and, at worst, an inconvenient and pricey account feature. But for low-income families overdraft fees can seriously derail a monthly budget and push an account holder into the margins of the financial world. Many of the millions of Americans who survive without bank accounts once had them, but shuttered them—or had them involuntarily closed—because of difficulty keeping up with fees, such as overdraft. And the lack of bank accounts can push people into dangerous, high-cost products, such as payday loans, auto-title loans, or fee-laden prepaid cards. Fixing overdraft, then, may be a straightforward way to help more Americans reconnect to safer financial systems.