Forty dollars for a Big Mac? That might sound over the top, but it barely tips the outrage meter when you compare it to the 20,000-percent-interest loan U.S. consumers regularly take out to pay for such $40 burgers. How could this be?
Well, bounced checks just aren't what they used to be.
A new study says that most of the time consumers overdraw their accounts now, bounced checks aren't the culprit. Instead, debit card purchases are chief cause of overdrafts.
Many people don't realize that a carefree swipe of their debit card at a point-of-sale terminal to buy a Big Mac could result in "courtesy overdraft" fee of $30 or more. But such fees are becoming increasingly common. When faced with a transaction that would send a consumers' account into negative territory, banks now regularly approve such transactions, cover the expense, and charge hefty fees.
Financial institutions collected some $10 billion in 2005 through what's sometimes called automatic overdraft protection, according to the new study conducted by the Center for Responsible Lending. The agency reviewed full transaction histories for 5,000 typical American households to determine the cause of bounced check fees.
In its report, called "Debit Card Danger," the Center for Responsible Lending said that 38 percent of overdrafts were caused by debit card, point-of-sale transactions, while paper checks triggered an overdraft only 27 percent of the time. Online bill payments accounted for another 27 percent of overdrafts.
Most consumers have no idea
The trend concerns Eric Halpern, who co-authored the report. He believes many consumers still have no idea how expensive that Big Mac can be.
"If you ask people on the street what would happen if they tried to make a debit card purchase and their account was empty, most people assume the bank would deny it," he said.
Not any more. Beginning several years ago -- no one really knows when -- banks slowly got into the business of granting short-term, high interest loans to consumers when they attempt to overdraw their accounts. Account holders are automatically enrolled in the programs, which are now standard at nearly all banks.
Why are the programs, which many people have never heard of, so popular? Financial institutions that adopt them can expect a huge spike in overdraft revenue -- a spike of 200 to 400 percent, according to the Center for Responsible Lending.
These mini-loans are incredibly expensive. Most debit purchases that force overdraft loans to kick in are for small purchases, the agency says. The median overdraft loan for a point-of-sale transaction is $14.75. The average fee is more than double that amount. And since most consumers pay these loans back within three to five days, the annual percentage rate on a courtesy overdraft loan can be as high as 20,000 percent.
It's clear these loans confuse consumers. When asked, 61 percent said they wished the bank would simply reject the transaction.
In a paper world, fees make sense
Courtesy overdraft can save consumers money in the world of paper checks. The fee is the same as a standard insufficient funds fee, but consumers who would have bounced checks without it won't face additional fees from merchants.
But the advantage ends in the electronic transaction world. Consumers who are unaware of courtesy overdraft do not know that the price of their Big Mac can jump from $1.99 to $42 in an instant.
It's true, as bankers like to say, such fees are avoidable. Consumers can keep tabs on their balances, and as long as they do not live near the edge, dangling their balance near zero, they will never see this fee. And in fact, most consumers never pay overdraft fees. Every consumer who spends money they don't have bears responsibility for that.
But banks shoulder the blame, too, for making it so easy to overdraw -- and for muddying the line between "where the consumers' balance ends and the overdraft protection begins," said Greg McBride, a senior financial analyst at Bankrate.com.
Remember the surge of marketing that began a few years ago encouraging consumers to use debit cards instead of credit card for purchases? Debit cards were supposed to be the safer tool, the preferred tool for consumers trying to be responsible about their personal finances. Because debit-card buyers draw instantly from their own money in their checking accounts, they do not run up high-interest, revolving credit card debts. The implication, of course, was that debit cards would not allow you to spend what you don't have.
There are other factors that make it easier to fall prey to courtesy overdraft fees. Balancing a checkbook has become a much more complex affair. In an age of Internet banking and multiple automatic payments and deposits, it is easy to lose track of account balances day by day.
In addition, the advent of electronic check processing (called Check 21) has meant check deductions are drawn faster from consumers' accounts -- but deposits are still commonly held for three to five days. So consumers need a healthy cushion in their accounts to avoid the near occasion of overdraft sin, and not everyone has such a cushion.
"This hits families who are living paycheck to paycheck," said Halpern. "It is likely at (any) point in time that the consumer does not know their exact balance. But the bank knows the exact balance."
Banks could warn consumers that an overdraft is imminent, he said. But instead, they approve the transaction and collect the fee.
"This is a situation where the bank has much more information than the consumer," he said.
Liz Pulliam-Weston, author of "Deal with Your Debt," and MSN.com personal finance columnist, says that there are easy ways for consumers to protect themselves from overdraft fees. With a simple phone call or visit to a branch, consumers typically can link their checking accounts to their savings account or credit card. Then, if an overdraft occurs, the money to cover the purchase will be drawn from their other accounts. A small fee will apply, but it will generally be a tiny fraction of the potential courtesy overdraft charge. Consumers can also apply for a bank line of credit and link that to their checking account, Weston said.
Many consumers may be confused by the various names for overdraft protection – bounce protection is costly, courtesy overdraft is costly, traditional overdraft protection is not.
But Weston offers a simple rule of thumb. If you are using your own money to cover an overdraft, that's inexpensive. "But, if you are borrowing the bank's money, that's expensive," she said. "Everyone should have true overdraft protection."
Online banking can help also, she said. While bank Web sites don't always provide an exact,up-to-the-moment balance because transactions may not post immediately, the sites are useful for monitoring balances.
There's one more warning consumers should have, Weston said. Not only can they unknowingly overdraw by making debit card purchases, but they can overdraw while getting cash from ATMs, too. That might not sound possible -- after all, once upon a time, ATMs would simply deny withdrawals that exceed balances.
Scratch that, too.
Banks ignore customer data
Many banks now allow consumers to withdraw money from the kitty included in the automatic overdraft protection. Bank customers hate this idea – only 2 percent said they wanted banks to permit such withdrawals and tack on their overdraft fees. Most said they'd rather the withdrawal was rejected.
Instead, banks seem to be encouraging the use of these short-term loans to get cash, perhaps as a way of competing with the tide-you-over short-term loans offered by various paycheck advance loan retail stores. There are reports that banks even pad the "available balance" displayed on ATMs with amounts from the courtesy overdraft kitty. In other words, a consumer might only have $50 in their account, but an ATM might indicate a $250 "available balance." Then a $100 withdrawal would incur that $39 overdraft fee.
It's not clear how common the practice is -- the matter is being examined now by a federal agency in a major overdraft fee study that's due late this year. But McBride said it is indeed happening.
"It's elusive to pinpoint how prevalent this is ... but I know anecdotally that it's happening," he said.
The problem doesn't appear to be extensive. In the Center for Responsible Lending study, only 2 percent said they'd been forced into overdraft protection by an ATM withdrawal.
Still, the only real defense against an ATM that might lie to you about your balance is to keep your own cushion in the account.