Scam is a harsh term that gets thrown around a little too casually, especially on the internet. However, sometimes it is entirely appropriate. This is one of those times.
A Brief History
During the worst of the recent recession, banks were charging hefty overdraft fees when a consumer’s spending exceeded the funds in their account. The classic example at the time was a customer getting a $2 cup of coffee, inadvertently overdrawing their account, and getting hit with a $35 overdraft fee. As the economy went downhill, banks raised these fees, with overdraft fee revenue peaking at $37 Billion in 2009. There was debate about the validity of these fees, with many saying that the banks were making a nice profit each time this happened. To combat this issue, laws were passed stating that customers had to “opt-in” to be eligible for overdraft protection. Our leaders in Washington figured that most customers would simply prefer that their debit card be declined rather than spending $40 on a cup of coffee.
Results of the Changes
Yesterday the Consumer Financial Protection Bureau released a report detailing the effects of the opt-in procedure on overdraft fees. The CFPB is the federal agency with supervisory and enforcement authority over banks with assets in excess of $10 Billion. According to Richard Cordray, the director of the CFPB, “What is marketed as overdraft protection can, in some instances, put consumers at greater risk of harm.” He went on to say that, “our findings raise concerns about the number of consumers who are incurring heavy overdraft fees or account closures, and the wide variations across institutions indicate that certain practices and procedures merit further analysis.”
The “wide variations across institutions” that Director Cordray spoke of, showed that at some banks over 40% of new customers chose to opt-in to overdraft protection while less than 10% did at other comparable institutions.
The CFPB report showed that 27% of customers incurred an overdraft fee in 2011, and of that group, the average yearly overdraft fees totaled $225.
How the Scam Works
Due to the new laws regarding overdraft protection, banks must get customers to sign up for their overdraft service. Remember, some banks are able to get over 40% of their new customers to sign up.
The most egregious part of the scam comes in manner in which transactions are processed. According to page 44 of the CFPB report, the processing order varies from bank to bank. Some banks process transactions from in order from high to low, rather than the logical approach of doing it chronologically. This allows them to maximize overdraft fees.
Let’s say a customer has $30 in their account at the beginning of the day. This person gets a coffee and a doughnut for $5 on the way to work. For lunch, this person spends $8, and stops by the store to spend an additional $10. On the way home, this person realizes that the tank is on empty and spends $40 on gas. It would seem that this day should result in one single overdraft fee. However, some banks will charge an overdraft fee for the $40 transaction, a second overdraft fee for the $10 transaction, a third overdraft fee for the $8 transaction, and finally, an overdraft fee for the $5 coffee and doughnut at breakfast.
Based on this example, what would appear to be one transaction above the limit, could result in quadruple overdraft fees. Some banks are able to charge up to 12 overdraft fees per day!
Avoiding the Scam
Step number one, and the most obvious step, is to avoid spending more money than you have in your account. As seen by the example, the accountants can be pretty creative when it comes to balances. Because some banks will even process all of the debits before the credits, a good rule of thumb would be to only spend money that was in your account the previous day.
Secondly, think very carefully about whether or not you want overdraft protection. For some, it might be worth the $35 fee. Make sure you understand exactly what you are signing up for. Ask about the processing order. Ask about how overdraft fees are charged. Ask what would happen if you didn’t have overdraft protection. Finally, make sure you get your answers in writing. If you don’t, and you get stuck with an incorrect fee, you will never be able to prove to them what you were told.
Like most financial pitfalls, this is another one where awareness is the best medicine. Knowing what can happen, and taking steps to prevent it, can save you hundreds of dollars and a lot of frustration.
Are you signed up for overdraft protection? What do you do to avoid getting stuck with these fees?