The Overdraft Fees Ripoff
Have you ever been burned by your bank’s “creative accounting” when it comes to overdraft fees? Or maybe it was your former bank and that’s exactly the reason why they’re your former bank! There’s a big scam running in the banking system, and it involves overdraft fees and how they’re imposed.
Overdraft Protection
Before banks started implementing “overdraft protection“, things were simple. Anytime the bank is presented a check for an amount that would overdraw your checking account, it was simply returned NSF (Non-Sufficient Funds) and a fee of $10 or $15 was deducted from your balance. Your remaining balance (after deduction of the fee) remained intact and available to cover smaller checks or charges that showed up. Nowadays with “overdraft protection” if a large check arrives, it gets paid, you’re charged a $35, and your account turns negative, and from then on, every single additional check or charge that arrives is guaranteed to “overdraw” and trigger another $35 fee. Even a $1.99 charge will get hit with another $35 fee.
Transaction Processing Order or “Biggest Check First” Policy
You can still get burned in yet another way. Back in the old-days, checks and charges were handled during nightly processing, usually in the order in which they arrived. But now most US banks use a “biggest check first” posting order, by which items posting to a customer’s account post according to the amount of the item, as opposed to the transaction date. The “Biggest Check First” policy is common among large U.S. banks. They keep a temporary ledger in their computers that records transactions as they occur during the day. This temporary ledger is what you see when you do online banking. But then during the night when the computers reconcile all the accounts, the temporary ledger is ignored and all of your transactions for the day are re-executed in the real ledger. The transactions are not handled in the order they occurred during that day, instead they are sorted by dollar amount and the largest transaction is entered first, then the next largest, and so on.
Banks argue that this is done to prevent a customer’s most important transactions (such as a rent or mortgage check, or utility payment) from being returned unpaid, but this also has the effect of maximizing fee income since the larger items deplete the account balance causing multiple overdrafts by smaller items that present on the same day. Consumers have attempted to litigate to prevent this practice, arguing that banks use “Biggest Check First” to manipulate the order of transactions to artificially trigger more overdraft fees to collect.
For example, let’s say on the morning of a particular day I have a balance of $100. During the day I use a debit card to buy a videogame for $65, a snack for $5, and then lunch for $10. During the day, if I checked my balance with online banking, my balance would have gone from $100 to $35, to $30, to $20. If I thought that those transactions are accounted for and deducted from my account in real time, I would be sadly mistaken.
If during this same day a $90 check arrives at the bank to be paid, common sense would suggest that it will bounce. But that’s not what happens. The check will get processed at midnight but so will all my previous transactions that day. All four transactions will be re-processed into the main ledger at midnight, not in the order of occurrence but in order of decreasing dollar amount. First comes the check for $90, which clears fine because my balance is still $100. My balance then drops to $10. Then the $65 debit card transaction, driving the account to $-55, plus the $35 overdraft fee to $-90. Then the $5, and the $10 transactions, each of which carries another $35 fee. The next day my $150 positive account balance has become overdrawn by $175.
Compare that to the transactions being recorded in order of occurrence, where I would have $35 deducted from my $20 balance, leaving me owing the bank just $15.
Regulators Stepping In: H.R. 946
On February 8, 2007, Representative Carolyn Maloney, Chairwoman of the Financial Institutions Subcommittee (D-NY), Financial Services Committee Chairman Barney Frank (D-MA), and Representative Julia Carson (D-IN) introduced legislation to protect consumers from abusive overdraft loan programs and stop financial institutions from deliberately manipulating their systems to generate more overdrafts—while preserving the institutions’ ability to cover occasional overdrafts as a courtesy without triggering the Act’s requirements. The Act would:
1. Amend the Truth in Lending Act to clarify that overdraft fees are finance charges, so that annual interest rates are reported. Consumers would then be able to compare the cost of overdraft loans with the cost of other credit options.
2. Require written consent before enrollment in the overdraft loan program.
3. Require financial institutions to warn the customer when an ATM withdrawal will trigger a fee—and allow the customer to cancel the transaction at that time.
4. Prohibit financial institutions from manipulating the order of check clearing to increase customers’ overdraft loan fees
My take? Overdraft fees as they are currently applied are a very bad financial proposition (at least for the consumers) and something definitely needs to be done. The Center for Responsible Lending estimates that Americans pay $17.5 billion per year in fees for these loans that many borrowers never asked for and in many cases can’t afford.
June 9th, 2008 at 9:14 am
A very well-written and informative article.
The best defense against bank overdraft fees is, of course, to track all transactions to prevent overdrafts. The primary responsilibilty - and control over the situation - is in the hands of the account holder.
Many people make mistakes in their calculations, though, that can trigger some pretty huge fees. What I’d like to see is immediate notification available via e-mail- not having to wait 5-6 days until a notice arrives in the mail (and more checks bounce). This is why it’s good to check accounts online every day.
June 9th, 2008 at 9:43 am
BeThisWay,
Thanks for the compliment! I agree with your point, but the truth is that even if you’re careful you can still get hit. But hey, I guess we just have to be EXTRA careful
June 11th, 2008 at 9:29 pm
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