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How Bank Overdrafts Are Worse Than Payday Loans

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Did you know that the largest banks in the country are registering huge profits by checking overdraft fees? This is forcing the country’s poor to “subsidize the rich”.

Often, those with a fund crunch situation need an overdraft. And quite often, these are the same poor people who would take a payday loan to ride over the immediate crisis. But while the payday industry faces criticism, the banks have largely been allowed to carry out their operations as they please. In fact, the banks have been busy actively encouraging people to get an overdraft, so that they can make a profit. For instance, in 2014, the banks raked in a massive $35 billion from overdraft fees.

If you don’t have $50, how can you pay an extra $150? This is a frustration and annoyance, particularly to those who already don’t have enough money.

Banks have been exploiting their customers for a really long time. Legislation has been passed to prevent this, but the banks have always found a way to manipulate the system, as you will find a little later in this post.

And yet, there is hardly any criticism of the banks, while you will see so many negative comments about payday lending, which is often the only solution for those who need the money urgently, and those from poorer sections of the society.

How Credit Changed

The way people borrowed money began to change after World War Two. Credit itself started to change with the decline of open-book credit (shipping of goods with the receiver’s promise of paying) and pawning. Other loan forms like credit cards, overdraft protection and payday loans replaced them. But everyone did not have access to overdraft protection. This was limited to only those who had high incomes but were facing short-term issues. But slowly, with time, more people were able to get overdraft protection. Credit unions and banks began to offer them during the mid-1990s, allowing their customers to overdraw their debit or checking accounts.

By 2003, according to a report, about 1000 banks were letting their low-balance customers overdraw their accounts, often by skirting credit laws, and by doing this, they were raking in billions of dollars as fees. So these banks were encouraging people with limited funds to spend beyond their means, just because they wanted to earn their fees.

The banks did this as the overdraft fee was a more stable income source to them, as compared to other products where the interest rate fluctuated. The FDIC carried out a survey in 2006 and reported that overdraft fees were 6% of the net operating revenues on average.

This worsened with time. Data collected by SNL Financial revealed that in the first quarter of 2015, Bank of America, Wells Fargo, and JP Morgan Chase together collected $1.14 billion from overdraft fees and other related service charges. And not just that, these same banks collected the most ATM fees too in the same quarter.

Other Issues with Overdraft Fees

There are many other problems with overdraft fees, which work much like credit cards and payday loans, but are worse. For instance, according to a Consumer Federation of America 2005 report, overdrawing the account was much the same as using the credit card, but with a key difference. With credit cards, the banks cannot take money from a customer’s bank account directly for paying the card debt. But those who overdraw their accounts using a debt card do not get this protection. That’s because, banks are allowed to set-off when a customer overdraws with a debit card and immediately after the customer deposits money into his account. What the bank can draw out also includes the overdraft fees.

The same report also discovered that often banks were letting people overdraw money while paying checks, thus leading to overdrawn accounts. This was in the form of allowing ATM withdrawals, making point of sale purchases, and pre-approved debits, though there weren’t adequate funds in the account. And of course, the banks weren’t informing their customers about better alternatives.

Citizens Bank’s for example, was promising “’convenience and peace of mind” while offering overdrafts to their customers on their website. In late 2004, they said that customers will incur a fee between $25 and $33 for each transaction depending on how many days the account remained overdrawn. However, they did not inform that customers had the option of buying optional savings account overdraft transfer coverage for as little as $3 each month, and that, they could also apply for overdraft protection credit that costs just $20 every year. Both these options were naturally more affordable for their customers and less profitable for the bank.

It improved a bit in 2010, with rules on overdraft fees coming in. Starting in July of the year, banks had to now allow their debit card customers to enrol for overdraft fees, instead of automatically charging anywhere between $20 and $30 whenever there were inadequate funds for covering a purchase. So, the debit card could now also be declined at the point of sale if there were inadequate funds.

How the Banks Began to Manipulate the System

But the banks found a way through fee manipulation. A federal judge asked Wells Fargo to pay customers in California $203 million in restitution for claims that transactions were manipulated for maximizing overdraft fees. That was in August 2010. This is what happened – instead of treating each transaction when it was received, Fargo arranged them in the largest to smallest transactions, and as a result, customers ended up paying increased overdraft fees.

But Wells Fargo wasn’t the only one doing this. Bank of America had to dish out $410 million for the same reason the next year. Forbes reported that banks continued manipulating their fees in their 2012 Consumer Financial Protection Bureau (CFPB) report. It was clearly spreading.

According to a 2013 report by The Center for Responsible Lending, the banks were charging an overdraft fee of $35 on average. And not just this, some of them were even charging the “sustained overdraft fee” if the account stayed overdrawn for many days. Some banks were charging a one-time additional fee of $35, while others were charging between $6 and $8 every day till the account balance returned to positive. So the problem worsened unless their customers could find the money quickly.

Customers Who Suffered

It was found that 8% customers incurred close to 75% of all overdraft fees. But this worsened, as the FDIC discovered that in 2008, 9% of all checking account customers were paying 84% of the overdraft fees. The poor were the most to suffer as they found that overdraft fees were disproportionately affecting the low-income and young customers. This finding was validated in a CFPB 2014 report. They reported that 10.7% customers between the age of 18 and 25 years were taking more than 10 overdrafts every year.

The Poor Are Paying For the Rich

What happens effectively with overdraft fees is that, the poor end up subsiding the rich people. The Economist reported in an article that according to the FDIC, those who are making less than $30,000 were twice more likely to take an overdraft. And often, these low-income people ended up unable to pay the fees.

The banks would naturally close their indebted accounts when this happens. It would almost be impossible for these people to open an account with another bank. So they get shut off from the formal banking system, and often turn to pre-paid cards that charge all kinds of exorbitant rates. They have to end up paying for things that usually comes free, such as loading funds into the card, cutting a check, talking to a customer service rep, and for point of sale buys. The fee can be as high as 5% for each check, no matter what the nature of the check is.

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