Overdraft Loans

Consumers receive overdraft loans when a bank or credit union lends them money to cover a transaction that puts the consumer’s balance in the red.  In exchange for this loan, banks charge fees which average $34, even if the purchase was only a few dollars.

In the past, financial institutions would deny debit card purchases or ATM withdrawals if there wasn’t enough money in the consumer’s account.  Recently, they have taken to routinely  enrolling many of their account holders into  expensive overdraft “protection” programs – an option customers generally don’t want and often aren’t even aware of.  The banks then approve the transactions, imposing a hefty fee for each one.

• Facts and Stats

• Overdraft Loan Abuses

• A Note about Checks and “NSF” Fees

• Sources for More Information

Overdraft Loan Facts and Stats

• An overdraft fee of $34 for a $3.40 cup of coffee translates into a 1,000% annual percentage rate (APR) if you repay the loan in one year.  If you repay the loan in one week, the APR is a staggering 52,143%!

• Overdraft loans cost consumers $17.5 billion per year, more than the $15.8 billion extended in funds to cover the overdrafts.

• A small group of consumers is paying the majority of fees.  Sixteen percent of overdraft loan users account for 71% of overdraft loan fees.

• Americans who depend heavily on Social Security income pay nearly $1 billion per year in fees for unauthorized overdrafts.

• Some banks advertise overdraft loans as a way to make it until the next payday. 

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Overdraft Loan Abuses

• Automatic enrollment: Seventy-five percent of banks enroll their customers automatically in overdraft "protection" programs without asking permission.

• No cancellation option:  Some banks do not even allow you to cancel your enrollment in these programs.  

• Surprise!  Overdraft loans are often a total surprise.  Consumers assume that if their purchase is approved or they are able to withdraw money from an ATM, they must have sufficient funds in their account. They may not find out otherwise until much later, by which time the bank has charged numerous fees.

• Deceptive information:  Even when bank customers check their available funds at an ATM before making a withdrawal, the amount that the screen shows often includes the overdraft protection limit in addition to the amount in the account.  The result is that customer is fooled into making a withdrawal that results in an overdraft protection fee.

• Snowball effect:  After the bank or credit union charges the fee and then pays itself the amount of the overdraft from your next deposit, consumers may be short on cash for essential expenses.  They may overdraft again just to stay afloat, creating a snowball effect which quickly sinks them deep into the red.

• Pretending it’s not a loan:  Financial institutions and bank regulators obscure the fact that this is a loan by calling the practice “overdraft protection.”  Don’t be fooled:  overdraft protection is really just a very expensive loan.

• Tricks which trigger overdraft loans:  Many banks or credit unions cover checks or debits made on an account in one day from “high to low,” meaning that the largest checks or debits are covered first, regardless of the order in which they arrive at the bank.  This maximizes the possibility that an overdraft and can result in a cascade of fees.  When the largest withdrawal is paid first and all other checks waiting to be covered bounce, the bank imposes an overdraft fee on each of the smaller transactions.  On the other hand, if the bank covered transactions based on the order they arrive at the bank, more might clear before the account balance hits $0.  In this case, the bank would charge fewer bounce fees (and make less profit).

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A Note about Checks and "NSF" Fees

Banks also make overdraft loans when an account doesn’t have enough money to cover a check that a customer has written.  In this case, the overdraft fee is usually the same amount as the "non-sufficient funds" (NSF) fee that the bank would charge even if it denied the check.  Since the consumer would pay the NSF fee either way, the overdraft loan does actually protect the customer from the hassles and additional fees involved with bouncing a check.

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More information about overdraft loans

Studies, reports, and more data about overdraft loans

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AFFIL is grateful to the Center for Responsible Lending for their help with this page.
Last Update:  February 2010.