Millions Use Overdraft Programs to Borrow Money

Inside Subprime: Aug 27, 2018

By Lindsay Frankel

An estimated 39 million Americans are charged overdraft fees for their checking accounts each year, and these fees disproportionately impact low-income consumers. For some, overdraft programs can prevent transactions from being declined, meeting the needs of the customer. But according to Pew Charitable Trusts, 12 million people use overdraft to borrow money, even though these programs are not intended to replace small-dollar loans. Millions of people also pay penalties when they have insufficient funds for a debit or ATM transaction, when they could instead have these transactions declined without incurring costs.

What’s more, research shows that banks often neglect to thoroughly explain overdraft programs to their customers. As a result, the majority of consumers using overdraft aren’t aware that they can avoid fees on ATM and debit card transactions by opting out of the program. According to the Consumer Financial Protection Bureau, these customers pay an extra $450 annually when compared to those who choose not to opt in.

Democrats have proposed policy changes intended to protect consumers from unsafe products. U.S. Senators Cory Booker and Sherrod Brown recently introduced the Stop Overdraft Profiteering Act of 2018, which Booker says would put a stop to unfair practices. “These fees generate enormous amounts of revenue for the banks while most customers don’t even know they’ve opted into such charges. Worse yet, overdraft fees fall on those least likely to be able to afford them – individuals for whom a $35 overdraft charge could push them over the brink into financial ruin,” Booker said.

But similar efforts have failed to address the problem in the past. And while the CFPB has taken action against banks for deceiving customers, these enforcement actions have not impacted the misuse of overdraft programs. These programs are not a suitable form of credit in part because consumer credit laws do not apply to overdraft programs.

Unfortunately, many people who use overdraft as a form of credit may lack alternative options. People with bad credit are often tempted by high-cost payday loans, which can incur triple digit interest rates. Part of the battle is for banks and credit unions to offer better products to meet the needs of consumers. To assist financial institutions in providing affordable credit options, Pew has made recommendations for automated small-dollar installment loans that would be safe and fast for consumers yet still profitable for banks. For these loans, total fees could not exceed half of the loan principal.

Financial institutions, with guidance from regulators, need to steer the way towards safer options for borrowing money. In order to prevent undue financial harm on low-income families, banks and credit unions should develop safer alternatives to payday loans and communicate these options to their customers.

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