4 Reasons Excessive Overdraft Fees Just Won’t Go Away

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Despite regulatory reform aimed at reining in checking account overdraft fees, the penalty is still a cash cow for banks — to the tune of about $31 billion a year. That’s down from $37 billion in 2009, but a new report from the Consumer Financial Protection Bureau makes clear the number ought to be far lower. Why? Because customers who opt into so-called overdraft protection plans — which are marketed as a way to avoid unnecessary fees — end up spending more on checking account fees than those who don’t. 

It would appear that banks have little motivation to clear up this, ahem, unintended consequence: Overdraft fees account for at least 60% of fee income on checking accounts. Perhaps if the causes for this confusion were made clear, however, consumers could protect themselves. Here’s are four reasons this problem is so persistent:

Pricy “protection” plans that don’t protect. In 2010 the Federal Reserve prohibited banks from enrolling customers in overdraft plans that automatically charge $35 per transaction if customers try to buy something without having enough money in their accounts. Instead, the Fed mandated, customers would have to voluntarily opt in to these programs.

In response, banks mounted a marketing blitz that made overdrafts sound really scary and recast overdraft penalties as “protection” fees, which got a lot of people to opt in without realizing what they were signing up for. A May 2012 study by Pew found that more than half of people who paid an overdraft fee didn’t realize they’d opted into the expensive plan. The CFPB finds that roughly nine out of 10 banks offer a less expensive linked-account transfer to cover overdrafts, but many banks customers today either don’t know about them or mistakenly believe something with the word “protection” in it must be better.

Too many names. Overdraft policies are hard for consumers to understand because, in part, they’re called something different by almost every bank. A May report by the Pew Charitable Trusts says a “lack of uniformity makes it hard for consumers to compare key practices across institutions.” For instance, overdraft fees are variously referred to as “courtesy pay,” “overdraft protection,” “overdraft coverage,” and “bounce protection.” That last term is especially misleading because bounced checks, along with electronic withdrawals made if there’s not enough money in the account, incur an insufficient funds fee even if the customer hasn’t opted in for overdraft coverage.The CFPB also finds the fee structures for overdrafts vary widely between banks: “Some, for example, limit the number of overdraft charges in a day to two; others have no cap on fees or caps that allow as many as 12 overdrafts and non-sufficient fund fees in a day.”

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

Banks game the system. Some banks strategically process transactions in a sequence that triggers bigger fees. Here’s how it works: Say you have $25 in your account. You buy breakfast for $5 in the morning and lunch for $10. Then on your way home from work in the evening you spend $20 on takeout for dinner. If the bank processed the transactions in chronological order, you’d get hit with only one overdraft fee — after buying that $20 dinner. But some banks order the days transactions from highest to lowest, processing the $20 expense, then the $10, then the $5. This means you get nailed with one fee after the $10 transaction is processed, putting you in the red, then a second one when the $5 transaction is processed. Instead of $35, you’re suddenly on the hook for $70.

Bank of America and JPMorgan Chase paid $410 million and $110 million, respectively, to settle class-action charges relating to this practice. Wells Fargo was ordered to pay $203 million and is still fighting it in court, despite an order last week reinstating the judge’s original decision.

The most at-risk consumers pay the biggest price. Some customers just can’t keep up once their balance goes negative and the fees start accruing. A small number of customers wind up paying the lion’s share of overdraft penalties. The CFPB says serial overdrafters saved an average of $450 in the second half of 2010 alone if they decided not to opt in after the new regulation took effect. Despite regulation, serial overdrafters still pay “substantial sums” in penalties, the agency says. Says the CFPB: “The great majority of involuntary account closures at the study banks are due to negative balances,” and overdraft fees are a big reason why.