Should You Be Able to Overdraft Your Checking?

Senator Chris Dodd, chair of the Senate Banking Committee has introduced legislation which would require banks to make overdrafts opt-in. I think this is something banks should do, legislation or no legislation. Unfortunately, it’s very profitable to banks to offer overdraft “protection.”

According to the Washington Post, these fees totaled $38.5 billion last year.

Checking Account Overdraft Protection – Fees

Right now, if you open a checking account with $250 and then spend $300, most banks will give you “overdraft protection.” It might be more accurate to call this “overdraft-getting-screwed.” Instead of denying your card for insufficient funds, the bank fronts you the money and charges a 1-time fee for doing so.

For example, instead of denying the debits on Lynnae’s account when a check (from another bank) she deposited bounced and she was short of cash, Chase put through each of her 8 transactions, each with a separate fee. Ouch. Lynnae was able to get the situation straightened out, but hers wasn’t just a miscalculation, it was the error on another bank’s part.

Banks often present this as a protection or a favor. In dire circumstances, it might be, but 99% of the time, it’s something the consumer doesn’t actually want. Most of us would far rather be denied a transaction than pay a $25 fee for a $1.20 coffee. My dignity (and coffee) in that situation isn’t worth $25.

Savings Account as Overdraft Protection – No Fee

When I was 18, I got my initial savings and checking accounts with a local bank (I’d had a juvenile account before). They offered a useful overdraft protection. I remember signing up to overdraft my checking account on my savings.

I never had an overdraft, but it was an incredibly practical and customer-friendly setup.

ING Direct has a moderately sane approach to the subject, setting up a line of credit for checking accounts. If you overdraft up to $500, you’re covered. And if you pay it back from one of your other ING accounts the same day, you shouldn’t accrue any interest. I’d prefer the option to link it with one of my savings accounts as backup (does anyone know if they’ve added this feature?), but since money can be instantly transferred once I have access to a computer, it’s pretty sane. Much better than fees.

Can You Opt Out of Overdraft Protection and Fees?

Yes. Many (but not all) banks and credit unions will allow you to call and opt-out. The proposed bill would require you to opt-in when you set up the account, meaning that you’ll get a chance to check out the fees and decide whether or not it’s worth it.

Opting out still won’t save you if you’re bouncing checks. Because checks don’t normally get the same immediate verification that debit cards, the bank won’t be able to stop people from accepting them.

The way things should work in a normal, sane world is that when you run out of money in your checking account, you’re done, you can’t use your card or withdraw money. If you have savings with a bank, it makes sense to have the option of putting that in place as a backup (though you run the risk of getting hit with the 6 savings account withdrawals per month rule). And in a sane world, you shouldn’t even attempt to overdraw–but things happen, like the bank check that bounced in Lynnae’s account (who can you trust to write good checks, if not a bank?).

But we don’t live in a sane world. We live in a world where convenience and easy credit often override personal responsibility and sound financial decision-making. And we live in a world where we can overdraft a dozen times and never be told, because it’s financially better for the banks to get fees off of us than stop us.

How are Banks Responding?

Banks have already responded to this threat by announcing plans of their own.

Starting October 19th, Bank of America will allow customers to opt-out of overdrafts entirely (I don’t know if they couldn’t before, or if the process has been improved). In June of 2010, they’ll impose a limit on the number of times people who didn’t opt-out can overdraw with a debit card (so you’ll actually know you’re out of money, eventually). New customers will have overdraft protection as an opt-in option.

Chase says they plan to allow consumers to opt-out. Also, they’ll change their controversial way of applying payments to an account. Suppose you’d spent $35, $10, $20, and $124 (in that order) using a debit card but only had $125 in your checking. Their old method of ringing it up would debit the $124 first, leaving you with three overdrafts and three fees. They’ll change to debiting in the order of the debits, which would mean that you’d only be hit with one overdraft and one overdraft fee.

The NY Times article linked above has more details.

Do You Support the Legislation?

So, do you support making overdrafts a required opt-in rather than an opt-out? Do you think banks would be willing to do it without legislation? Bank of America and Chase have made strides, but this comes as a response to the move for legislation. After all, banks made over $38 billion in overdraft fees last year.

And do you have any overdraft stories you’d like to share–were you able to resolve it or did you end up paying big?

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