Consumer Law

Do I Need Overdraft Coverage?

If you’re not careful, the cup of coffee that you buy with your debit card can cost you close to $40.

If you then buy a newspaper and a sandwich (in separate transactions), each of those items can cost you an additional $35. Picking up these three low-cost items on your way to work on a day that your account is empty can quickly rack up $105 in overdraft fees.

How does this happen? Many banks encourage their checking account customers to sign up for overdraft coverage. This service is not mandatory, but many people would prefer to avoid the embarrassment of being declined at a cash register or being caught with no access to money in an emergency situation. However, there is a steep charge for this comfort.

What Is Overdraft Protection?

Overdrafts occur when consumers spend or withdraw more money than is available in their checking accounts through the use of debit cards, ATMs, checks or direct debits.

Overdraft coverage is a service in which the bank pays the amount in question, even though the account lacks the necessary funds. However, the bank charges a $25 to $35 fee for doing so. This can add up to multiple fees daily. Often there are additional fees for each day the balance is not paid off. Without overdraft protection, the bank would simply decline the transaction.

An alternative is an overdraft protection plan, which ties a line of credit or your savings account to your checking account so that any checking account debit overdrafts are covered. There are generally fees for the transfer, but these are usually less than standard overdraft fees -- about $10.

Problems with Overdraft Protection

A 2013 report from the Consumer Financial Protection Bureau finds that customers who accepted overdraft coverage were more likely to pay hundreds of dollars in fees each year and have their checking accounts ultimately closed. In 2012, people who opted for overdraft coverage actually paid $347 more in fees than those who declined this protection, but still overdrafted and paid the associated fees.

Many banks process purchases or withdrawals in order of size - largest to smallest - rather than in chronological order. Processing one large payment first can use up all of the money in an account and then result in overdraft charges for each of the remaining smaller purchases.

Overdraft fees are a major source of income for banks. In large banks, they account for 61 percent of all checking account fees. In 2012, U.S. consumers paid $32 billion in overdraft fees. Obviously, banks do not want to see changes to these practices.

Overdraft Banking Law

Prior to 2010, banks could automatically charge overdraft fees for debit card transactions and ATM withdrawals. Since then, consumers must specifically “opt in” to this service. They can “opt out” at any time. Additional bills to tighten the rules are currently before Congress.

The “opt in” rules do not apply to checks or automatic bill payments that you set up for paying things like your mortgage, rent or utilities. You are automatically enrolled in a bank’s standard overdraft coverage for these types of transactions. Some banks will let you cancel this service.

Call a Consumer Banking Lawyer

The issues surrounding overdraft charges on a checking account can be complicated. Plus, the facts in each case and the laws in each state are unique. This article provides a brief, general introduction to the subject. It is not legal advice. For more detailed information about your specific situation, please contact a consumer banking lawyer.

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