Overdraft Protection

Posted by Mike Smith :: August 1, 2007 @ 6:12 am

There were times when the thought of bouncing a check was scary for multiple reasons: a returned check fee, feeling of shame, and loss of trust. Nowadays, it's even scarier what may happen when you're protected from bouncing a check.

Many banks offer overdraft protection. While these services have typically linked your checking account to a secondary funding source, such as your savings account or a line of credit, a new alternative is quickly becoming a huge revenue source for banks. This new form of overdraft protection is known as an overdraft loan.

Overdraft loans work like this: If you have insufficient funds to cover a check (or debit card transaction), the bank will still process the transaction and basically loan you the money to cover it. The bank will then take its money back the next time you make a deposit. Of course, the bank will also charge you a fee for this loan.

While the fee for an overdraft protection loan may be comparable to a returned check fee, and may save you the potential embarrassment of bouncing a check, the Center for Responsible Lending recently reported some startling facts about fees for overdraft protection:

• Overdraft loans generate $17.5 billion in fees for banks and credit unions each year
• More than two-thirds of fees for overdrafts come from overdraft loan fees
• The $17.5 billion in fees were generated by only $15.8 billion in overdraft loans.

While overdraft loans average $27, fees on the loan average $34. Any time a fee is higher than the actual loan, you have to question the practice that's generating the fee.

To make matters worse, the report also describes suspicious bank activities that may make the fees occur more often. These activities included: holding cleared deposits as long as allowed by law, failing to warn customers about automatically being enrolled in overdraft protection services, and processing larger checks before smaller ones as stated in yesterday’s post on banking.

To be fair, each of these practices must be considered from the bank's perspective as well. While it sometimes seems that banks’ motives are to generate as many fees as possible, the banks do not appear to be doing anything illegal. In fact, they may even being doing some of these things in the customers’ best interest. For example: by cashing larger checks first, banks allow larger, and presumably more important, purchases to go through, at the cost of potentially generating more fees as the smaller transactions repeatedly trigger overdraft protection loans.

We encourage you to review your bank's policy on overdraft protection. Until you know exactly how it will handle overdrafts, it's difficult to say whether or not the bank’s practices are fair. I wish that all financial institutions could be as simple and straightforward as Lending Club, but experience has taught us all otherwise.