Guide to Understanding Overdraft Fees and How to Avoid Them

Checking accounts come with a lot of fine print that account holders often aren’t aware of until it’s too late. For so long, overdraft charges were included in that fine print. However, in recent years, government officials have created rules to protect consumers from losing money because they were uninformed about bank guidelines and fees — like overdraft fees.

What Are Overdraft Fees?

Overdraft fees are the penalties banks charge if you withdraw more from your checking account than you currently have deposited. You can overdraw your account when the bank approves a debit transaction from a check, ATM withdrawal, debit card purchase or ACH payment (such as an automatic bill payment), even though it exceeds the available balance in your account.

The fees that are assessed from exceeding your available balance can vary depending on how the overdraft occurs — as well as the state you live in — but could reach as high as $35 per item.

What is Overdraft Protection?

Overdraft protection can apply to debit card purchases, ATM withdrawals, checks and ACH transfers and often covers up to $750 in purchases each month. It serves as an alternative to the consequences of exceeding a checking account balance in any other circumstance.

For instance, if a customer attempts to make debit card purchase or ATM withdrawal with insufficient funds in the account, the cashier or ATM machine will fail to process the transaction and the card will be declined.

In the case of the ACH transfer, insufficient funds will result in the payment being declined along with one or more non-sufficient funds (NSF) charges. And if you write a bounced check, you’ll not only have to pay fees, but could face greater consequences such as a report to Telecheck or even jail time if you bounce more.

While overdraft protection seems like the obvious choice for individuals looking to avoid the consequences of insufficient funds, many don’t understand that opting into the protection actually means paying high overdraft charges.

Because these types of programs have created confusion over the years, the government has taken steps to make it easier to understand, while attempting to govern the overdraft charge/protection business that has earned banks major profits.

How Important Is the 2010 Overdraft Protection Law?

Banks have been earning big bucks by charging overdraft fees for some time. In fact, these fees have reportedly accounted for as much as 27 percent of their income, helping them rake in $39.1 billion in 2009 alone.

Lawmakers say part of the reason banks have been so successful at acquiring overdraft fees from customers is the methods they use to ensure account holders mistakenly overdraft their accounts.

One alleged trick of the trade has been to rearrange the order the transactions clear in accounts, making sure that deposits are delayed while purchases are pushed through quickly. Banks have also been known to process transactions in order of largest dollar amount, instead of actual dates and times the transactions occurred.

To create some guidelines for how banks manage overdraft charges and protection programs while granting customers power over their accounts, the Federal Reserve implemented new rules on Aug. 15, 2010.

The rules, often referred to as the overdraft protection law, make it so that consumers who had unknowingly opted-in to overdraft protection programs now have to sign written approval before being granted the protection.

So with the new law in place, can banks charge overdraft fees? The answer is yes. If you opt into an overdraft protection program, you will still pay overdraft charges for debit card purchases, ATM withdrawals, ACH transfers and checks that exceed your available balance.

But if you don’t opt-in and exceed your available balance, you will pay the traditional charges for ACH transactions and checks, while your debit card transactions at store cash registers and ATMs will be declined with no penalty.

The law was meant to protect consumers from paying fees when they could avoid them completely, which is the case with debit card transactions. So now, rather than paying a $35 fee for accidentally overdrawing when buying a $5 coffee or $10 pizza, you will simply be unable to make the purchase.

Is Opting Into an Overdraft Protection Program Ever a Good Idea?

Now that you know the rules of the new overdraft fee law, is it a good idea to opt-in to an overdraft protection program with your bank? Believe it or not, doing so does have a few perks.

For one, you can avoid the embarrassment of having your card declined when trying to make an important purchase. Also, overdraft protection can come in handy if you’ve run out of gas or have some other emergency and need the cash.

And while it’s certainly not recommended, overdraft protection could also be used as a loan to help you survive between paychecks.

So then what are the cons of overdraft protection?

First, if you don’t use your protection wisely, you could rack up hundreds of dollars in fees within a matter of hours.

Also, if you’re looking for a way to make ends meet while you’re waiting on your next paycheck to arrive, overdraft fees are among the least affordable of all types of loans out there, including the interest rates you’ll find from payday lenders.

Alternatives to Overdraft Protection

As you consider whether or not you should opt-in to an overdraft protection program, it’s good to know there are other options available:

• Link to another bank account: One option to consider if you want lower-cost overdraft protection is to have your bank link your checking account to another checking or savings account with your bank. In many cases, banks charge around $10 per transaction for the service, but it beats the larger fee you’ll pay for having the bank cover it for you.
• Link to a credit card: Another option is to have your checking account linked to your credit card. It usually comes with the same per-transaction charge, but accomplishes the same goal and only leaves you in debt to your credit card company.
• Spend cash: Rather than run the risk of spending too much with your debit card accidentally, consider withdrawing the amount you need from an ATM and spending the cash instead.

Taking any one of these options allows you to always have backup funds without the worry of a large fee per item. It also saves you the trouble of having your card declined when making an important purchase.

What’s New In the World of Overdraft Protection?

Since changes have taken place under the 2010 law, banks are prohibited from imposing overdraft protection on their consumers. However, there have been reports of consumers feeling forced by their banks to opt-in, largely due to aggressive marketing tactics.

The Consumer Financial Protection Bureau (CFPB) said in February it has taken note of this and other questionable behavior by big banks like Wells Fargo and JPMorgan Chase and plans to examine the following bank practices more closely:

• Out-of-sequence debits
• Over-the-top marketing campaigns
• Qualify of information consumers receive on overdraft programs

Also, the CFPB says it will consider requiring banks to include a “penalty fee box” on checking account statements that details the fees consumers are required to pay.

But as these rules and guidelines get worked out, the Federal Deposit Insurance Corp. (FDIC) recommends that you learn more about overdraft charges and the new law to decide whether overdraft protection is for you.

And if you discover that your bank has opted you into an overdraft protection program without your permission, you are urged to contact the FDIC or the National Credit Union Administration (if your account is with a credit union) to file a report.