The Real Lesson Behind Excessive Overdraft Fees

When you remove the financial safety net, and individuals understand the choices, they are surprisingly good at doing the right thing.

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What’s more effective: consumer protections or consumer education that leads to sound individual decision-making?

There is a place for both. But those who question whether financial education works would do well to consider the Consumer Financial Protection Bureau’s new report on bank overdraft fees, which in my opinion demonstrates that when individuals understand their choices, they will protect their pocketbook all on their own, thank you very much.

Unfortunately, as the report also shows, individuals too often do not understand the choices. That is the watchdog bureau’s central finding and helps make the case for greater regulation. The report concludes that “each institution’s overdraft policies, procedures, and practices are highly complex and can be difficult for a consumer to navigate.”

Among the overdaft complexities:

  • Complicated fee structures Bank polices vary widely. Some cap daily overdraft charges to two a day while others allow you to pile up insufficient funds fees 12 times a day.
  • Coverage limits Some banks have fixed limits on how much they will lend on a check or debit with insufficient funds; others vary the limits based on average daily account balance, overdraft history, and deposit patterns.
  • Complex transaction postings The order in which check, debit card, and other transactions are posted to an account can influence the number of overdraft fees—and banks all do this differently. Some process transactions at periodic intervals throughout the day, some only at night. Some process debits in order, some from largest to smallest during a single day.

You can see why confusion reigns. But it was another part of the report that caught my eye: The fact that so-called heavy overdrafters reduced their bank fees by a significant amount after declining overdraft protection. “The average checking account fees per account holder who chose to opt in (to overdraft protection) were $196 in 2011, while the average fees for those who did not opt in were $28,” the report states.

(MORE4 Reasons Excessive Overdraft Fees Just Won’t Go Away)

Just to be clear here, I’ll reiterate: The people who did not opt into “overdraft protection” spent far less on fees than those who did opt in. How can this be? How can a person incur seven times more fees with overdraft protection than without it? One explanation, again, is that the rules are so confusing that individuals don’t understand how to manage the feature; those with overdraft protection paid through the nose out of confusion and misunderstanding.

But another way to read this data is that once individuals chose to skip overdraft protection they understood that they were on their own and became a lot smarter about managing their money as a result. In other words, when they felt they had a backstop they didn’t pay attention. But when they understood that the backstop was expensive, and got rid of it, they quickly learned how to watch their pennies.

We have a broad debate in this country about how to approach consumer protection and financial education. Should we try to teach people how to manage their money and protect themselves? Critics say it doesn’t work; most people will never learn, they argue. Or should we ask government to erect financial safeguards at every turn? That’s what the Consumer Financial Protection Bureau is doing, and without question it is helpful. But we’re better off if individuals know they have to protect themselves and are equipped to do so — and this report suggests that’s a realistic goal.

(MORE: They’re Baaack: Americans Paid $31.6 Billion in Overdraft Fees in 2011 — and the CFPB Ain’t Happy)

14 comments
scottd22
scottd22

If excessive overdraft fees illegality (violation of contract law) was actually enforced, no bank would go out of business for the simple fact that they would no longer offer "free checking" and would charge a monthly fee for their accounts. Additionally, bank CEOs would make far less money, but at least they would not be raping those with low incomes. Additionally, consumer education won't do squat for those who are poor. You can opt out of "overdraft protection", but you'll still be hit with $1k+ in NSF fees if you're poor and can't bring your account up in the event of tragedy.

bsmith1300
bsmith1300

It is exteremly simple to avoid overdraft fees...don't spend money you don't have.  What happened to personal responsibility.  Regardless of whether the overdraft programs are confusing or not, I know how much money I have and I don't spend more than that and I don't pay any fees.  Pretty simple, huh.  Ignorance is not an excuse for more government regulation.  Regardless of whether you agree with bank overdraft protection methods, government regulation will lead to the "good" (educated) consmers, those that use their account responsibly, paying for those that cause losses, scam the system, or those who are simply irresponsible.  Banks rely on fee income to reduce the rates and fees they charge to their "A" and "B" customers, again, it's that simple.  This is a completely non-paritsan, unpolitical analysis.

JeanieS
JeanieS

I work for a small community bank.  If it were not for overdraft fees, our bank would lose money every month and probably go out of business.  Customers have to opt in, and most choose it because it keeps them from getting hit with late fees that are higher than our overdraft fees.

kuei12
kuei12

The best thing to do is opt out of overdraft protection from your bank. If you don't have it, don't try to spend it.

JimB210
JimB210

The idea that consumer education will work is true, and no doubt it is helpful to educate consumers as much as possible. However, the banks need to be regulated, because the banks have really smart people figuring out how to make their overdraft policies complex and confusing, specifically to increase fee revenue. Further, banks are also 'educating' consumers, with bank's advertising working hard to convince consumers to make a choice that is based on the evidence not in their own best interests (opting out) but rather banks efforts are to convince consumers to sign up for the overdraft "protection" that leads to higher revenue for the banks, directly at the cost to the consumer. So in addition to consumer education, the banks need to be regulated. A perfect outcome would be to extract the funding for consumer education from the banks... which have really smart lobbyists and MBA's working hard to prevent that.

JeremyLiggett
JeremyLiggett

It does cost the bank significantly to have to charge off accounts with significant overdrafts. However, to charge nearly the same amount as a year's worth of interest on a small mortgage in two weeks is extremely excessive.

JeremyLiggett
JeremyLiggett like.author.displayName 1 Like

 @BradFoleyI used to work for PNC - I no longer work for a financial institution - and there were (at least by PNC) several campaigns undertaken to attempt to inform customers of the ability to do just that. In fact, by default, PNC in 2011 opted every single one of its customers 'out' of overdraft coverage, meaning they would not be 'covered' in the event there were insufficient funds in their account. Confusingly, this meant that there card would be 'declined' if there weren't enough funds in their account. Overdraft coverage, what I just described, is different however from overdraft protection. Overdraft protection transfers money from one account to another to cover the initial account from being overdrawn. With the number of ways that you can check your bank account, which are very secure, despite what paranoid people who think the AOL Instant Messenger 'yellow guy' icon has a camera spying on the inside of their house, might tell you. You can go to any atm, you can check an app on your phone or computer, hell, you can even call the bank if you're really THAT unsure that you might spend more money than you have. It's no one's responsibility but your own to make sure you can cover yourself. IMO.

datracker
datracker

@JeremyLiggett @BradFoley But there is a thing called false positives. This is when people have written a check or paid at a biller site and those payments have not posted to their account. Therefore the amount that your bank shows in your balance is not correct because it is showing more money than you actually have (a false positive balance) and this is the reason people still need to track their spending.

BenIncaHutz
BenIncaHutz

The bottom line is that "overdraft protection" was not a consumer protection. It was a way for the bank to generate free money.

BradFoley
BradFoley

I don't know why in the US you can't just see a *transaction declined* or a *are your sure you want to go ahead* message at the point of sale if you're overdrafting. When I lived in Australia (6 years ago) this was in place, and I never had an overdraft. It took me a couple very confused experiences in the bank before I understood that this "for your protection" rule meant that I was unprotected.

datracker
datracker

Tracking your money is critical to financial control and the way to avoid fees. The banks can be misleading but you knowing your balance and tracking your money will not be. New product, the first smart checkbook register, the Debit Tracker helps you build the good habit of tracking your money.

BenIncaHutz
BenIncaHutz

@datracker  Debittrack does not good if your bank likes to re-order debits from largest to smallest. 

datracker
datracker

@BenIncaHutz @datracker --not true---regardless of how the bank reorders your bill payments, the new Debit Tracker unit will show you your balance before you spend your money and before your bank knows your balance. They have actually tried to out wait me and see if they could beat me and haven't. However the one thing no one can beat is if they hold up your deposit dates.