Beware Courtesy Overdraft Protection

Here's a piece courtesy of the e-book Banking Secrets Revealed:

In the past few years, many banks and credit unions have implemented a program called “Courtesy Overdraft Protection”.  While that name sounds nice, it is simply another name  for “High Priced Overdraft Loan”.  Banks and some Credit Unions like this product because it enables them to get a significant boost in fee income while providing a so-called “service” to their customers.

Courtesy Overdraft Protection works like this.  Banks or Credit Unions place their customers on the Courtesy Overdraft program, sometimes without their knowledge.  If the customer writes a check that they don’t have funds to cover, the bank or credit union will cover the check temporarily.  The bank or credit union will still assess a fee for insufficient funds to the customer but the check has been paid.  The next deposit made by the customer will help to cover the short term loan.

Many customers like the concept of Courtesy Overdraft Protection.  From their perspective, they’ve written a check that they don’t have funds to cover.  The bank or credit union pays the check and assesses a “small” convenience fee.  The customer’s creditor is none the wiser.  Their bill has been paid and they don’t assess a separate fee to the customer for writing a bad check.  In addition, there is no black mark on the customer’s credit report.

The banks or credit unions like the Courtesy Overdraft programs as well.  From the financial institution’s perspective, they are making a number of low-risk, short-term loans and getting fee income each time they do it.  Customers enrolled in these programs may be more likely to overdraft their accounts more frequently increasing the institution’s fee income even further.

Everyone wins….right? Wrong!  If you do the math these short-term loans come at a very high price.  For example, say you write a $500 check you can’t cover.  The bank or credit union covers the check for you and charges a $35 fee.  A week later, you get your paycheck and the loan is paid off.  For the privilege of a $500 loan for one week, you pay $35.  This equates to an interest rate of over 400%!  Who in their right mind would take out a loan with a 400% interest rate? No one, that’s who.  But this is one way banks continue to have record profits each year.

There is a better way.  Check with your financial institution to see if you can have overdraft protection from your savings account.  In that way, if you write a check without sufficient funds in your checking account, the money will come from your savings account instead.  You may even be able to set up overdraft protection from your credit card.  Yes, this would technically be a loan but it’s at a far lower interest rate that with the Courtesy Overdraft programs.

Comments

[Traciatim]

If the end results ends up at a credit card, why not just pay all your bills with the credit card and then pay the credit card off before the 21 day grace period. If you left the funds in a high interest savings account while they waited you could even make money one the deal. If it's just sitting in your normal account you can still use online bill paying to pay the card off in full and you never get assessed any fees.

I think people just need to wake up and stop paying fees, the banks will get the point if people stop being lazy and stupid.

[JM]

At BoA, I have a $1000 line of credit associated with my checking that automatically kicks in on the rare occasion I overdraft. The interest is not cheap (17%), but its not a flat $35 per incident. The couple times I have overdrafted in my life were saved any fees because of this, BUT the catch is, I had to really dig to even find out the existence of this feature, and even worse, I think the only reason I have it was because my bank was bought by bank of america and it was something I insisted on and they were happy to oblige to keep me as a customer.

I disagree however with your assertion that the rate on the overdraft 'loan' is 400%. It would be if it were a revolving credit account, but its not. Since you are paying it off next deposit, in your example its 7% interest. Taking its APR is like finding a $100 bill on the sidewalk one day and thinking "Cool! That's $36,500 in extra income per year!"

[snow_drops]

In my bank, if you don't have sufficient fund, you get charged $35 AND the check is not cleared. The overdraft protection actually makes it possible for the check to go through and I got charged $4.75 on the month when it occurs (and $0 otherwise).

So in my case, it's more profitable to have it. Of course, it's better to have the funds at any time. But people who wait-for-months-before-cashing-checks do exist.

[Traciatim]

Snow_Drops: If you have an outstanding cheque then you need to have the funds available in the account. If it's been 90 days it's irrelevant until such time as:
1) The cheque is cashed
2) The cheque is verified as unable to be cashed

I always like the idea of just keep a float in the account so in case you mis-judge the amounts by a few bucks your still good. I like to keep $100 in my account and that equals zero in my mind. That way you have your own overdraft. This costs me a few bucks a year in lost interest if it were in a high interest account, but at least the bank isn't charging me fees.

[Burns]

Attaching your checking account to your savings account is a terrible idea! If your check card gets stolen and used they can drain your savings dry, which leaves you nothing to get by on until things get cleared up. Banks usually charge a fee for this service as well (my bank charges $5 for every $100 transferred from savings). So in your $500 scenario, it would still cost $25 at my bank, not a good trade off in my opinion.