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The Cost and Economics of Overdrafts

Updated: Feb 28, 2021

What is an Overdraft Fee?

Overdraft fees are charged when a checking account does not have sufficient funds to cover a requested withdrawal or transaction, leaving the bank or credit union to pay the transaction.

Sometimes a pending transaction is posted later than expected, a check isn't deposited immediately, or perhaps a transfer you made wasn't processed quickly enough. All of these scenarios would leave you with non-sufficient funds (NSF), where banks or credit unions will charge an overdraft fee.

And with the ease of debit cards and new technologies, it's not uncommon to accidentally let a balance slip negative and therefore overdraw an account. With several bills varying in the amount owed, falling victim to an accidental overdraft can accumulate into an ugly mess of fees and headaches.

But it doesn't have to be so financially taxing. If payday is still a few days, or even a week away, frequently check your balance, replenish it, and ensure you have sufficient funds to cover bills and those sneaky monthly subscriptions.

If you receive paychecks via direct deposit, consider opting for automatic payments to optimize your overall financial wellness and stability.

Understanding the Costs of an Overdraft and Using Overdraft Protection

While the cost of an overdraft varies depending on your bank or credit union, the average typically centers around $34-$35. And throughout the COVID-19 pandemic, we have seen this affecting an increasing number of Americans. According to Bankrate, those affected on average are paying more than four times as much as those whose income remained unaffected by the pandemic.

A question you may ask yourself is, " What about using overdraft protection, and isn't that the best route to avoid an overdrawn account"? Perhaps it can be, but it comes with stipulations.

Most banks, if not all banks, will allow you to connect an existing account, like a savings account. Therefore, your funds can be automatically transferred to cover the overdraft amount. Now, you'll be able to complete a purchase instead of being embarrassed and out of luck — great! However, there's a catch for such services. Several financial institutions process and cover the transaction, but charge fees until the difference of the overdrawn balance are reimbursed.

On top of this, consumers are faced with paying the aforementioned $34-$35 overdraft fee along with any additional fees for each day the balance remains negative. Other establishments may apply the same combination of fees for each transfer from your reserves required to cover transaction differences.

Often, monthly service fees and/or daily fees will be charged and are directly proportional to the number of days the account remains negative. Not to mention having a bad check bounce, where you are likely liable to pay a returned check fee.

As you can see, the accumulation of all of these fees can become a burdensome expense. While overdraft protection certainly acts as a temporary type of "saving grace", it may also result in an overwhelming collection of fees if not dealt with swiftly.

Taking Preventative Measures and Avoiding Overdraft Fees

Of course, just like many stressful occurrences in life, taking preventative measures is the optimal strategy for evading excessive overdraft fees.

The following will help align your financial endeavors, and in turn, will help you avoid an overdrawn account

  1. Setup and Enable Alerts — Most modern banking institutions offer a means of notifying you when funds are low. Check to see if your account is eligible to receive email or text notifications. Establish a dollar threshold that will notify you when you're below the set limit.

  2. Check Your Accounts — In today's digital age, we're capable of launching a banking app and quickly analyze what our balances are. If you're a part of a credit union or smaller banking organization, try keeping note of each transaction you make. Save receipts and try to keep an updated balance slip in your wallet, so you can easily examine your balance before questioning a purchase.

  3. Transfer Funds — You may be able to prevent overdraft fees by transferring funds into the account the same day. If this policy doesn't exist within your organization, it's still best to deposit funds as soon as possible to avoid amassing daily overdraft fees.

  4. No Overdraft Coverage — Opting out of an overdraft coverage program essentially means your bank or credit union is unable to absorb single-time ATM or debit card transactions (buying something online), nor can they charge fees on them. However, recurring debit card transactions (gym membership dues), automatic bill payments, and checks can be paid for by your institution. By opting out you may run into more declined transactions, but will likely face no penalty for it and will save money by avoiding coverage fees.

  5. Link a Direct Deposit Account — Ensuring your paycheck is automatically deposited into your checking account is a huge relief. It alleviates complications when dealing with daily transactions and bills and better keeps you prepared for automatic payments.

By adhering to these suggestions, you can prevent a cluster of overdraft expenses. Knowing how to avoid overdraft fees in advance will keep you financially sound in the future.

Impact of Overdrafts on Consumers and Financial Organizations

Lastly, we'll examine a series of statistics collected by the Consumer Financial Protection Bureau (CFPB) regarding fees absorbed by consumers on an annual basis and how much banks make on overdraft fees.

Impact of Overdraft Fees on Consumers

  • Consumers overdraw their accounts more often via debit card transactions than by any other means

  • In a given year, only 30% of consumers overdraw their checking accounts. The 8% of consumers who overdraft more than 10 times per year pay 74% of overdraft fees. These consumers are charged $380 in overdraft fees on average annually.

  • Consumers who opt-in to debit card and ATM overdraft coverage risk paying more overdraft fees. Specifically, opted-in consumers paid on average $22 per month in overdraft and NSF fees while non-opted-in consumers paid on average $3 per month.

  • Opted-in consumers averaged 7.78 overdrafts per year while non-opted-in consumers averaged just 1.99 overdrafts.

Source: CFPB 2017

Impact of Overdraft Fees on Financial Organizations

  • The CFPB estimates that roughly 80% of what banks report as overdraft and NSF fee revenues are accounted for by overdraft fees, with a small group of consumers paying most of these fees (CFPB 2017).

  • In 2015 the CFPB indicated that consumer overdraft and NSF fees reported from 628 banks — each with over $1 billion in assets and that offer consumer deposit accounts— totaled $11.16 billion in revenue, accounting for 8.0% of the reporting banks’ total net income and 5.5% of the reporting banks’ pre-tax profits.

  • Bank revenue from consumer overdraft and NSF fees are 65.4% of all consumer deposit fees paid for those banks that report this revenue for the 12 months ending September 2016 (CFPB 2017).

Clearly, there is significant revenue generated from banks and credit unions from consumer overdraft and NSF fees.

And as we've discussed, there are several approaches to stay on top of your finances to ensure a healthy account balance and to minimize the risk of overdrafts. Keep a keen eye on your spending habits, analyze your checking balance frequently, and maintain a disciplined financial mindset to best evade overdraft fees.