Incurring a small fortune in overdraft fees no longer requires a poorly-balanced checkbook.
To boost revenue, many banks have jacked up fees and reworked policies to maximize the potential for overdrafts, putting even the most diligent account holders at risk, says Jean Ann Fox, director of financial services for the Consumer Federation of America. "You can get in the hole for hundreds of dollars before you even know it," she warns.
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Indeed, financial institutions collected more than $17.5 billion in overdraft fees last year, reports the Center for Responsible Lending, a nonprofit policy group.
At the heart of the revenue stream: so-called courtesy overdraft policies, which allow banks to pay charges that would otherwise bounce. Instead of incurring an insufficient funds fee, account holders must pay an overdraft fee and reimburse the bank for the borrowed funds. Even worse: Most banks use software to single out and pay overdrawn funds without regard to the account holder's ability to pay back the overdraft and its associated fees. "It's the only form of credit that can be involuntarily imposed on you," says Chi Chi Wu, staff attorney at the National Consumer Law Center. "They've laid this tripwire, and there's no point to it except to generate fees."
Here are five ways a bank might try to trip you up with pricey overdrafts, plus advice on how to avoid them:
1. Debit and ATM Cushions
Contrary to popular belief, using a debit card won't prevent you from overdrawing your account. Debit card use triggers 46% of all overdrafts, according to the Center for Responsible Lending. "They allow the debits to go through, instead of rejecting them," says Ed Mierzwinski, consumer program director for the U.S. Public Interest Research Group. "It's disgraceful."
Solution: Ask the bank to set the debit overdraw amount on your account to zero. That way, any transactions that would put the account in the red will be rejected.
2. Reordered Debits and Deposits
Banks often change the order in which debits and deposits clear your account, making it tough to determine whether you're close to overdrawing. Bank of America, Chase, Citibank, PNC and Wachovia pay daily transactions in order from highest to lowest, according to a 2008 Consumer Federation of America survey. SunTrust, U.S. Bank and Washington Mutual use any processing order they choose.
Banks justify the practice as a way to ensure the most important debits get processed first (say, so a mortgage payment doesn't bounce). But according to Sharon Reuss, spokeswoman for the Center for Responsible Lending, it's really a way to maximize overdrafts. Say you start the day with $100 in your account. You buy a latte ($5), fill up on gas ($50), buy groceries ($35), swing by the drugstore ($8) and then the dry cleaner's ($25). Processed chronologically, only the last transaction triggers an overdraft. Reordered from high to low, however, three purchases do.
Solution: Buffer your account with an extra $100 or so that you don't intend to spend, advises Reuss. Also, don't count on deposited funds until they show up as part of the available balance.
3. Extended Overdraft Fees
Fail to promptly pay back a bank's courtesy overdraft, and they'll sock you with even more fees. SunTrust tacks on $35 after seven days. After three days, U.S. Bank charges $8 a day until the funds are repaid in full.
Solution: Set up real overdraft protection in the form of an attached line of credit, or automatic transfers from your savings account. It's much cheaper than the average $34.65 overdraft fee, says Wu. Citibank, for example, charges $5 annually for a line of credit. (Balances carry a 17.5% APR, however, so only use these accounts for temporary protection.)
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4. High Daily Maximums
Only 30% of major banks set a daily maximum for the number of overdraft transactions you can conduct, reports the CFA. Unfortunately, most of those limits are high, says Fox. Bank of America allows seven fees per day ($245 total), while U.S. Bank permits six ($199). Adding to the problem, many banks use a tiered overdraft system that escalates charges for subsequent overdrafts. Chase, for example, charges $25 for the first offense, and $32 to $35 apiece for subsequent charges — with no maximum.
Solution: Ask the bank to waive the fee(s). Also, point out that all of the fees stemmed from one incident, and, if true, that it's a rare misstep, says Fox.
5. Funds on Hold
Swipe your card at the gas pump and the merchant enacts a temporary hold for, say, $75 worth of gas, before the actual transaction begins. (Hotels and car rental agencies use similar procedures.) That hold lingers on your account for a day or more, even if the purchase turns out to be much less, warns Fox. Meanwhile, banks consider that hold money unavailable, thus lowering your available balance.
Solution: Use a credit card for purchases that put holds on accounts. While it still counts against your available credit, it's more likely that account can withstand a tighter balance for the 24 hours or so it takes for the hold to clear.