Everyday Law

Beware Overdraft “Protection”

Have you ever paid $38.15 for a grande, extra hot caramel macchiato with half 2% milk and half whole milk, one Splenda™, no whipped cream, but a drizzle of caramel on top?  I have.  $3.15 for the macchiato and $35 for an overdraft fee.

Boy, was I steamed!  It did not help to know that I was not alone – Americans paid $32 billion in overdraft fees in 2012. Many consumers assume that when you try make an ATM withdrawal or debit card purchase in an amount greater than your account balance,  the bank will simply reject the transaction.  However, that is often not the case. In fact, the bank can either reject or process the transaction, based on what you’ve told them to do.

In the past, consumers had no control over how the bank handled these types of transactions. Banks could decline all charges; pay all charges and charge the consumer an insufficient funds (NSF) fee; decline all the charges with one vendor and pay all charges (and charge a fee, of course) with another vendor; or any combination of the above upon a whim. Most consumers never asked the bank to cover their overdrafts; banks just started doing it and charging a fee for the service.

Starting August 15, 2010 for existing accounts and July 1, 2010 for new accounts, however, federal rules require banks to decline a debit card purchase if the account lacks sufficient funds, unless the consumer chose to “opt in” to an overdraft protection practice or program. These rules (The Federal Reserve Board rules, amendments to Regulation “E,” which implements the Electronic Fund Transfer Act (15 U.S.C. 1693 et seq.) (EFTA)) do not cover pre-authorized withdrawals, such as checks or automatic bill payments that you may have set up for paying your mortgage, rent, or utilities. Your bank may still automatically enroll you in their standard overdraft practices for these types of transactions. If you do not want your bank’s standard overdraft practices in these instances, talk to your bank; you may or may not have the option to cancel.

In the wake of this rule, many banks decided not to offer overdraft protection to their customers. If your bank does offer overdraft protection programs, though, you will need to decide whether or not to opt in.

If you choose not to opt into your bank’s overdraft programs, the bank will reject any transaction you attempt if there are insufficient funds to cover it. Although having your card declined may be embarrassing or inconvenient, it also saves you from paying the bank’s fees.

Otherwise, you may opt into one of your bank’s overdraft programs. The two most common  types offered: a “standard overdraft coverage” plan, under which the bank will process the transaction but charge an overdraft fee, usually around $35; and an “overdraft protection” plan, under which the bank ties a line of credit or your savings account to your checking account, and uses these funds to cover checking account overdrafts, usually for a fee of $10-$12, which is much less than the standard overdraft charges. Some banks offer other limited protections, such as those that cover only withdrawals from the bank’s ATMs, or only cover debit card purchases. Ask at your bank for the overdraft programs that may be available to you, if you are interested.

Although this law has been in effect for 5 years, there is still a lot of confusion amongst consumers about overdraft protection.  Many do not know if they have opted into their bank’s program because of the high-pressure tactics and confusing messages many banks utilized back in 2010. You can check your status with your bank, and opt in or out at any time. Others who opted in still don’t understand their bank’s programs, what charges may apply, and how their bank determines when an account becomes overdrawn.

Most consumer advocates advise against opting in to your bank’s overdraft plan. Although overdraft protection can save you from embarrassment and allow you to make necessary purchases before payday, it is essentially a very expensive loan. A study from the Consumer Financial Protection Bureau found that consumers who opt-in to their bank’s overdraft program end up with higher account fees and more involuntary account closures than those who do not opt-in.

Additionally, many banks’ policies make it very difficult to determine when an account may be overdrawn, and what fees may be charged.  Some common policies include:

Reordering transactions: This is the practice of changing the order in which transactions are processed to maximize the number of fees. For example, say you have $140 in your account, and make transactions for $20, $10, $50 and $100 (in that order). The account will be overdrawn no matter what, but the order in which the bank processes the transactions will make a big difference in the fees you pay. If they are processed in the order they were made, or in order from smallest to largest, only the last $100 transaction will overdraw your account, so there will be a single $35 fee. But if the bank processes them largest to smallest, only the first transaction for $100 will go through. The remaining three transactions will overdraw the account, resulting in $105 in fees!  Many banks have written detailed policies about the order in which transactions are processed; contact your bank for more information about its policies.

Authorization holds: When you swipe your debit card, the bank immediately holds the money for the merchant, but doesn’t take the money out of your account until the merchant settles the account, often several days later. You cannot access the held money. This is totally legal, and is necessary for the merchant to ensure they will be paid.

Unfortunately, if can often lead to overdrafts.  Some banks date the transaction the day they take the money from your account, others back-date the withdrawal to the date of the transaction. Additionally, when reporting your balance, some banks do not reflect the held, so it is not obvious how much of your money you can actually access. Not knowing which day the money will be considered debited can easily lead to overdrafts.

Another common authorization hold problem to be aware of is that many merchants (particularly gas stations, restaurants, and hotels) place a hold larger than the final bill. This is because they don’t know the final amount at the time they swipe the card. For example, when you swipe your card at the gas pump, they have no way of knowing how much gas you’re going to purchase, so the merchant places a hold on your account to confirm that the card is good and that there are funds available. This amount ranges from $1 to $100, depending on the merchant. Many restaurants get an authorization hold for an amount up to 20% higher than the bill, to cover a potential tip. If a diner pays for his $40 meal with his debit card and leaves a cash tip, he likely believes that his bank account is only down $40. In fact, though, the restaurant has held $48, which may cause his next transaction to overdraw his account. Unfortunately, most merchants do not alert consumers to their authorization hold policies, so the consumer has no way of knowing what amount will be held by the bank.

Irregular deposits: Federal law provides maximum periods for which a bank can hold deposits, based on factors such as where the check originates, who wrote it, and the amount.  This is a maximum guideline; the bank is free to release deposited funds sooner. Banks have been accused of releasing funds on an irregular schedule, sometimes crediting deposits immediately, sometimes at the end of their legally allotted period, making it difficult for consumers to gauge when deposited funds will be available, and increasing the risk of overdrafts.

Luckily, the use of some of these practices is dwindling, as banks change their policies amid lawsuits and court rulings. Banks such as Wells Fargo, Bank of America, and Citizen’s Bank have all faced class action lawsuits, and have had to pay consumers millions of dollars for using these unfair practices.

This information is provided so that you know what types of questions to ask your bank, and what to look for in the documentation your bank provides you about its policies and overdraft programs. Review this information carefully when deciding to opt in or out of overdraft protection. The point is to contact your bank; you are the one in control. And you can change your mind: if you opt in, you can cancel at any time. If you do not opt in, you can do so later.

Kelly Browne, June 2013
updated 7/15 mpj