Editorial Policy

6 tips cut bank overdraft confusion

Allie Johnson

September 3, 2014

You check your bank balance and get hit with a whammy: Your account is in the red due to an overdraft with hefty fees.

If that's happened to you recently, rest assured you're not alone. Many people still lack information about how overdrafts work, despite rules put in place four years ago to prevent surprise overdraft fees, experts say.

In 2010, the Federal Reserve started requiring banks to offer customers two options: Opt into overdraft protection and agree to the fees, or simply have your bank nix debit card purchases and ATM withdrawals that would overdraw your account. The rules don't apply to paper checks or automatic withdrawals.

However, in a 2014 report called “Checks and Balances,” Pew Charitable Trusts looked at the overdraft procedures, disclosures and fees of 44 of the 50 largest U.S. retail banks and found many to be anything but simple, according to Susan Weinstock, director of Pew's consumer banking initiative.

“There's a lot of confusion,” Weinstock says.

To cut through the confusion, we came up with six questions you should ask your bank or credit union about how overdrafts work.

  1. Do you have overdraft protection and how does it work? Learn your bank's or credit union's policies. For example, some banks allow overdrafts on debit card purchases but not ATM transactions, Weinstock says. And some large banks don't allow overdrafts at point-of-sale or ATM, says David Pommerehn, senior counsel at the Consumer Bankers Association, a retail banking industry trade group. In addition to overdraft fees, some banks add an extended overdraft fee, which means that if you don't get your account out of the negative within a certain time, you pay extra, Weinstock says. The average extended overdraft fee is $8 and the median length of time before it's charged is five days, according to the Pew report.
  2. Have I opted into overdraft protection? A Pew survey found that more than half of consumers who got hit with an overdraft fee after using a debit card did not know they had opted in for overdraft protection, Weinstock says. If you don't know or can't remember whether you've opted in, call your bank, recommends Rob Berger, founder of the personal finance blog The Dough Roller. Pew research shows 68 percent of consumers would prefer to have a transaction declined than pay a $35 overdraft fee, Weinstock says. If you've already opted in, you still can change your mind and opt out.
  3. What's your overdraft fee? About 75 percent of large banks charge an overdraft fee of between $35 and $38, Weinstock says. But consumers typically rack up more than one fee and, on average, end up paying about $69 each time they overdraft, Weinstock says. That's too high, she says. But Pommerehn disagrees: “It's a free market,” he says. Think your bank's fee is too high? Shop around, he says: “Consumers have the option to go to whoever they believe offers them the best deal.”
  4. What other options do you offer for overdraft protection? You can always choose not to opt in and do nothing else, which means your transaction will be declined if you lack funds to cover it, Weinstock says: “You walk away and you don't pay any fees.” But some banks offer consumers the option to link two accounts — for example, a savings account to your main checking account — charging a smaller fee when money is transferred to cover a shortfall. That fee typically is about $10, so it's considerably cheaper than overdraft protection, Weinstock says. Not all banks offer this, but if they do, it's an excellent option, Berger says. Or, some banks might allow you to link your checking account to a credit card or a line of credit, according to the Consumer Financial Protection Bureau.
  5. In what order do you post purchases? Some banks post purchases chronologically, while others reorder them from the highest to lowest amount or vice versa. “There's no one best way to post,” Pommerehn says. “There are benefits and drawbacks to each way, depending on the consumer.” Many banks have switched from posting from the highest amount to the lowest, to posting lowest-to-highest because it can result in fewer fees, Pommerehn says. However, some consumers might want larger amounts –such as a rent check — to post first, he says. A Pew interactive tool shows that a hypothetical consumer who overdraws her account on a dinner date, could end up with a balance of negative $49.67 or negative $154.67, depending on how the bank posts her transactions. Switching posting order can turn one overdraft fee into four or five, Weinstock says.
  6. Do you have an overdraft threshold? Partly due to anecdotes about $40 lattes — when consumers get hit with a $35 overdraft fee after buying a $5 cup of coffee — more banks have instituted an overdraft threshold of $5 or $10, Pommerehn says. So, if your account is overdrawn by less than that amount, you won't get hit with an overdraft fee. “That takes care of the argument that consumers are paying $35 for a cup of coffee,” Pommerehn says. About 69 percent of banks either have a threshold or no overdraft fee, Pew found.  An overdraft threshold could mean the difference between owing your bank a few dollars or having to come up with $75 or more to get your balance out of the red, Weinstock says.

The bottom line: Manage your finances carefully, Berger says: “Work with a bank you trust that has low fees, and take responsibility for your money.”