Overdraft Loans
What’s in the name?
Overdraft loans are called “overdraft protection” by the banks who make them to their customers. Consumer advocates call them “bounce” or “overdraft” loans. They are marketed by some banks to their customers who “run short on cash between paydays.”
Who makes these loans?
Banks make short-term overdraft loans only to their customers—those who have bank accounts at their institution.
How do they work?
Over the last few years, banks have changed their way of operating when covering overdrawn checks or ATM withdrawals. Traditionally, banks might have covered a check when your account contained insufficient funds. Banks would use their discretion in these circumstances and might charge a fee, depending on the customer’s account history. Banks usually did not honor overdrafts at ATMs, until recently.
Now many banks automatically cover overdrawn amounts up to a maximum of $500 or so, including ATM cash withdrawals. Banks then charge a flat fee and sometimes a daily fee until the loan is repaid from your next deposit. Unlike traditional overdraft protection, these “services” do not require consumer consent. They do not provide cost of credit disclosures under federal lending laws, or guarantee that the bank pays the overdrafts.
What are the abuses?
- Automatic enrollment: Banks may enroll their customers in overdraft "protection" programs without asking permission. This puts you in the position of having to personally go to the bank and cancel. Overdraft loans are often a total surprise. Often consumers assume that if their check clears of they are able to withdraw money from an ATM, they must have sufficient funds in their account. You may not find out otherwise until much later, by which time the bank has charged you a lot of fees.
- Just like a payday loan: After the bank charges the fee and then pays itself the amount of the overdraft from your next deposit, you may be short on cash for essential expenses. The bank’s program of paying overdrafts for you can lead you to overdraft just to stay afloat. This triggers fees each time which eats into your income.
- Pretending it’s not a loan: Banks obscure the fact that this is a loan by calling the practice “overdraft protection.” You don’t think about this practice the same way when it’s called by the wrong name, but don’t be fooled: overdraft protection is really just a very expensive loan.
- No ability to repay: Banks do not assess the consumer’s ability to repay these loans. So, if you overdraw your account, the bank will take its fee from the next deposit into your account, even if you needed that money to pay rent.
- Cascading fees: Many banks cover checks or debits made on an account 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 of an overdraft and can result in a cascade of fees. For example, when the largest check is paid first and all other checks waiting to be covered bounce, the bank imposes an overdraft fee on each of the smaller checks. On the other hand, if the bank covered checks and debits based on the order they arrive at the bank, more checks might clear first. In this case, the bank would charge fewer bounce fees (and make less profit).
- High fees and interest rates: If you calculate the overdraft fee as annual interest, the rates can range from 100% to 3000%, depending on the amount of the overdraft, the amount of the fee, and the length of time until it is repaid. You may have thought that your money is safe in a bank---but it isn’t.
Are overdraft loans legal?
Yes, at the present time! And worse, the Federal Reserve Board recently endorsed meaningless disclosures that come on your monthly bank statement and don’t tell you the annual interest rate cost of the overdraft loan.
What can you do if you have an overdraft loan problem?
AFFIL can’t guarantee that help is on its way, but these are our best suggestions.
- Call your bank: You can ask the bank to block the automatic overdraft program so that it won’t work on your account.
- File a complaint: You may file a complaint with the Federal Reserve Board and the Office of the Comptroller of the Currency.
Even if the bank has followed acceptable procedures in charging you fees, you may wish to let these regulators know that you don’t like this product. - Find a lawyer: AFFIL is not a lawyer referral service and cannot refer you to a specific lawyer. If you want to talk with a lawyer who might help you with your debt problems, you can review the list of members of the National Association of Consumer Advocates (NACA). You can also contact your state bar association’s lawyer referral service.
- Contact your state legislator: You may also write to your state legislator and ask that your state regulate overdraft loans to better protect consumers.
- Contact your federal legislator: You may also write to your U.S. Congressperson or Senator. It is important that they know your story so they can decide whether changes in the federal laws need to be made.
Where can I find a better small loan product?
It is likely that your bank can offer you a line of credit that can kick in if you overdraw your account. This type of credit is very inexpensive when compared to an overdraft loan. The interest rates might range from 10% to 20%. If you have a savings account, the bank may cover overdrafts automatically from your savings at little or no charge.
Also, if you need a small loan, see the Consumer Federation of America’s site on this topic. CFA is an AFFIL partner.
What do we know about this industry?
Overdraft loans are made only by banks and credit unions. These fee-based programs have expanded in the past few years. From 2003 to 2005, the number of banks using a vendor-based overdraft loan program increased almost 80 percent to 3,500 institutions. Some banks advertise this program as a way to make it until the next payday.
How much do overdraft loans costs consumers nationally?
Overdraft loans cost consumers well over $10 billion each year. A small group of consumers is paying the majority of fees. Sixteen percent (16%) of overdraft loan users account for 71% of overdraft loan fees.
