Overdraft Fees

Overdraft Fees
An overdraft fee is a penalty banks charge an individual for making purchases that cannot be covered by the funds in their account.

What’s an Overdraft Fee?

Banks charge overdraft fees—usually a fixed amount—as a penalty when there are insufficient funds in a checking account to cover a customer’s transaction.

How do Overdraft Fees work?

An overdraft fee is a penalty for using more money than your account contains. For instance, if you have $5 in your account and you use your debit card to buy a $10 lunch, you’ll spend $5 more than you have. The bank will automatically deduct the amount you overdrew ($5), as well as the overdraft fee, directly from your next deposit.

An overdraft fee can occur with several forms of payment:

  • Debit card transactions
  • ATM withdrawals
  • Checks
  • Automatic bill payments

How are Overdraft Fees calculated?

Overdraft fees vary from bank to bank, but most national banks charge at least $35.[1] They usually assess the fee every time a customer overdraws their account, which can happen multiple times in a single day.

Many banks also charge something called a “sustained overdraft fee” if the customer doesn’t deposit funds and the account remains overdrawn for several days. At some banks, the sustained overdraft fee is an additional one-time fee that usually costs around $35. At other banks, the fee ranges from $6 to $8 and is charged daily until the account is returned to a positive balance. Some banks have placed limits on the number of overdraft fees they charge in a day, but these caps still often allow for fees totaling hundreds of dollars.[2]

What are overdraft protection programs?

Banks only charge overdraft fees if they allow the transaction to go through. They have the option of denying it, and the Center for Responsible Lending noted that as recently as 2004, 80 percent of banks declined debit card transactions that exceeded a customer’s funds. But now many banks enroll account holders in “overdraft protection” programs. These programs allow account holders to exceed the amount of funds in their account, but the banks assess overdraft fees when they do.

In the past, many customers were enrolled in overdraft protection programs without their knowledge. A law enacted in 2010 requires that customers be informed of the overdraft programs and have the option to opt in or opt out, but a 2014 Pew study found that more than half of people who overdrew their accounts don’t remember signing up for one of the programs.[3]

Why do banks charge Overdraft Fees?

Banks have argued that overdraft “protection” and the fees that come with it allow customers to avoid bouncing checks. If a customer overdraws an account, the transaction will go through and the customer will pay the overdraft fee—and not the fee for the bounced check assessed by the merchant. The idea is that banks are saving customers from merchant fees by allowing them to overdraw their accounts.

However, this logic doesn’t hold for debit cards and ATM withdrawals, which account for a large portion of overdraft fees. With debit cards and ATM withdrawals, a denied transaction won’t trigger a merchant fee—it just means that the person won’t be able to pay for something or withdraw funds. While some customers might opt for a service that allows the transaction to go through with an additional charge, others would prefer to have the transaction denied and not have to pay a fee.

Do Overdraft Fees hurt you credit score?

The short answer is no. Experian—a credit bureau that produces the reports used to determine credit scores—states that overdraft fees don’t affect credit scores. However, if the account remains overdrawn and the money isn’t repaid, the bank may report the account holder to a collections agency, which could hurt their score.

How can I avoid Overdraft Fees?

If you overdraw your account, you’re almost certain to face an overdraft fee from your bank. The best way to avoid them is to make sure to opt-out of overdraft protection. Do this by contacting your bank.

If you choose to opt-in to overdraft protection, the government offers two pieces of advices to avoid overdraft fees:

  1. Check your account balance regularly. Make sure to watch your account and keep track of transactions like ATM withdrawals, debit card purchases, automatic bill payments, and checks. If your balance gets too low, hold off on transactions until you deposit more funds.
  2. Connect your checking account to a savings account. If you link your checking account to your savings account, your bank can automatically transfer funds from one to the other if you overdraw the checking account.

References:

  1. The Pew Charitable Trusts. “Consumers Need Protection from Excessive Overdraft Costs.” Dec. 20, 2016. Accessed on December 27, 2016 at http://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2016/12/consumers-need-protection-from-excessive-overdraft-costs.
  2. Borne, Rebecca, and Peter Smith. The Center for Responsible Lending. “High-Cost Overdraft Practices.” July 2013. Accessed on December 27, 2016, at http://www.responsiblelending.org/sites/default/files/uploads/8-overdrafts.pdf.
  3. Vasel, Kathryn. “Consumers are Still Getting Hit with Huge Overdraft Fees.” CNN, May 12, 2015. Accessed on December 27, 2016, at http://money.cnn.com/2015/05/12/pf/overdraft-fees/.