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Debit card overdraft protection: when to avoid it, when to opt in

4 cheap ways to duck overdraft fees -- and 3 times to consider opting in

By Dana Dratch

Should you opt in to an overdraft program that, for a fee, lets you make debit card charges when there's not enough money in your account?

It's a hot question for a lot of consumers.

Debit card overdraft protection: when to avoid it, when to opt in
HIGHLIGHTS OF FEDERAL OVERDRAFT FEE RULES

What: The Federal Reserve has implemented rules that require banks to get consumers' permission -- that is, they must "opt in" -- before the banks can charge overdraft fees when there's not enough money in an account to cover purchases.

Who is affected: Anyone with an ATM or debit card. The rules took full effect Aug. 15, 2010.  

What's not covered: Banks can still charge whatever they want for overdraft fees. They can also assess multiple fees during a single month.

4 low-cost alternatives to overdrafts

3 times you may want to consider opting in 

Thanks to federal overdraft protection rules that went into full effect Aug. 15, ATM and debit card transactions won't go through if there isn't enough money in the account to cover them. In other words, when your balance hits zero, the card stops working.

The only exception: if the customer has set up some type of overdraft protection. The banks used to automatically enroll customers in overdraft protection; the new rules require them to get customers' permission -- that is, "opt in." Because the fees are lucrative, some banks have aggressively pushed their overdraft protection programs.

One recent study, by the nonprofit National Foundation for Consumer Counseling, found that 74 percent of customers are telling their banks "no thanks" when it comes to fee-based overdraft protection.

Another study, by the American Bankers Association, an industry group, put the number at 49 percent with 5 percent undecided.

"For some, that $30 overdraft fee is worth the peace of mind," says Carol Kaplan, spokeswoman for the American Bankers Association.

Others disagree, believing that consumers either don't understand what they're signing or erroneously believe the opt in covers all bank transactions including checks. (It doesn't.)

"They're confused," says Ed Mierzwinski, consumer program director for the U.S. Public Interest Research Group. "Opting in helps the banks and hurts them."

With a fee-based overdraft programs, the account will keep working into the red, usually until the balance hits about negative $500 for most people, according to Kaplan. 

Every time a transaction goes through, the customer pays a fee. And debit card overdraft fees are averaging about $34, according to the Center for Responsible Lending.

ATM and debit card overdraft fees totaled $10.5 billion in 2008 alone, according to the Center for Responsible Lending.  The average transaction amount that triggers a debit card overdraft fee: $20.

As a consumer, it doesn't make sense to pay $39 for a $5 latte. But it's also galling to get shut down at the checkout when you're trying to get home with a week's worth of groceries.

Cover overdrafts for

VIDEO: Should you enroll
in overdraft protection?

New federal rules require banks to get your permission before they enroll you in overdraft protection. Should you opt in? Before you decide, watch this video. Also, check out this helpful chart of major bank overdraft fees.

little cost
What you may not know: You can have the best of both worlds -- overdraft protection without high-dollar fees.

"Overdraft protection is presented in marketing as a binary choice," says Rebecca Borné, senior policy counsel for the Center for Responsible Lending. "The truth is there are options."

4 low-cost alternatives to overdraft
Instead of checking that box and signing your name to opt in to a fee-based program, you can get overdraft protection in at least four other ways:

1. Link your checking account to a savings account. Then, if you overdraft, money is transferred from one account to the other. What you pay: a much smaller transfer fee -- usually about $6 to $15, says Mierzwinski.

"Customers should watch the upfront transfer fee -- both the amount of the fee and the way it's charged," says Borné. "For example, it's generally far cheaper for the fee to be charged for each large dollar increment transferred than per incident."

2. Link your checking account to a line of credit. If your credit is good, you can link your checking account to a line of credit. Banks will issue the lines with rates around 18 percent, says Mierzwinski. And, for a loan whose duration will number in the days, that interest amounts to $1 or $2, plus the transfer fee.

The trick here: Unlike fee-based overdraft programs, just putting the borrowed money back into your account doesn't wipe out the loan. You have to write a designated check to the bank to pay off the debt, he says.

And, as with anything involving transfers, watch those fees.

3. Link your checking account to a credit card. Many banks will also allow you to link your checking account to a bank-issued credit card. The process works in much the same way as with a line of credit, sans check-writing.

4. Build a buffer. Don't have a savings account or can't qualify for credit? How about just padding your checking account? An extra $10 or $20 every time you get paid adds up quickly. Before you know it, you'll have a three-digit cushion between you and disaster.

This method is also good for people who have savings and good credit because there are no pesky transfer fees. The trick: Pretend the money isn't there.

A small savings, says Borné, "is the backup that is so much better than disaster scenarios."

3 times you may want to opt in
In a few circumstances, though, you may want to consider opting in. Do you see yourself in any of the following three scenarios? Then you might consider opting in to the bank's fee-based overdraft protection

1. You use your debit card to pay occasional bills. Paper checks, automatic bank drafts and regular, recurring bill payments via debit cards are not covered under the opt-in rules. So if you've set up certain bills to automatically draft via your debit card, and there isn't enough money, your opt-in doesn't mean the bank will pay the bill. But if you use your debit card occasionally to pay bills, then your opt-in does count.

The worry for bill-payers: If a debit card payment is refused, the payee (power company, phone company, etc.) will likely levy their own set of fees.

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In this instance, it's smart to have some protection for your account. Your least expensive option: Either stop using the debit card to pay bills, or use one of the four low-dollar protection options.

2. You travel regularly and don't have a credit card. By now everyone knows about the temporary blocks and holds that some hotels, gas stations and other establishments sometimes put on cards. Use a debit card and that practice freezes actual cash in your account. End result: You might be traveling with less money than you anticipated.

So is overdraft protection a good idea? A backup would be wise. But at $34 per charge, a road trip can take you to that negative $500 limit pretty quickly. More fiscally sound: ask about holds (and whether the establishment can forgo them) before you present your card. And investigate one of the four less expensive overdraft options to backstop your account.

3. You're living close to the financial edge and consider fee-based overdraft protection a short-term "loan." You have a lot of company. If you're talking about buying food, medicine or making the mortgage, and you don't have other options, a fee-based program might be your choice.

Look at the numbers, your behavior
Before deciding, do the math. Look at your past year's debit charges.

Ask yourself:

  • How many fees did you pay?
  • How much did the fees set you back?
  • Did the fee-based program save you any money (in fees payees would have charged for nonpayment or disconnection)?
  • Did overdraft protection enable you to buy critical supplies (like food or medicine), or did it just drain your next few paychecks and leave you further in debt?

When the Center for Responsible Lending started analyzing several consumers over a year's time, they found that, in the long run, participation in fee-based overdraft programs tends to perpetuate debt rather than relieve it.

For consumers, "it's a more expensive way to live," says Borné. "They are always robbing Peter to pay Paul."

See related: The high cost of opting in to overdraft fees, Federal overdraft protection rules require customers to opt in, Debit customers fume at blocks, holds

Published: September 22, 2010


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