'Bounce Protection' Costs Consumers Plenty
When checking accounts dip into the red these days, banks are making a lot more green.
U.S. consumers pay some $17.5 billion each year in "bounce protection" fees, a new generation of high-cost loans that have virtually replaced older, cheaper systems of overdraft management and have become a cash cow for banks, the nonprofit Center for Responsible Lending said in a study released Wednesday.
These fees significantly exceed the amount of the loans (the amount by which those consumers fall into the red), estimated at $15.8 billion. So in essence, consumers caught in the system are paying an additional $1.11 for every $1 overdraft–a hefty interest rate–even though most overdrafts are resolved within five days.
Just two years ago, the center estimated that the amount of these fees was about $10 billion per year.
In the past, the center noted, consumers opening a checking account were given the option of linking it to a source of backup funds, like a savings account, or even to a line of credit with an annual interest rate of less than 20 percent. But the dawn of sophisticated overdraft management software and favorable federal regulation prompted banks and credit unions to shift to the new loan system, which is more costly to the consumer.
Because the Federal Reserve Board exempts this type of overdraft loan from the Truth-in-Lending Act, consumers typically are enrolled by default–without signing anything–when they open their checking accounts. Often, they don't realize their first overdraft will automatically be covered–at a price.
The fee, says the Center for Responsible Lending, may seem small, at about $34 per overdraft on average. But it is large in comparison with the average overdraft amount, only about $27.
The system can quickly become costly for consumers, because of software that helps the banks multiply the fees through practices like high-dollar ordering of checks received. When a bank receives a batch of checks, including one large check that would empty the account–that high-dollar item is cleared through the account first. An overdraft fee is charged on that item and then again and again on all subsequent items in the batch. If the batch were ordered from low to high, a consumer might see the fee only on the last high-ticket item.
Sellers of the overdraft software that helps banks manage such systems promise banks that their customers will be happy because overdrafts will be covered, while at the same time the banks increase the fees they charge. Strunk & Associates tells banks it will help them "cultivate closer, more valuable account relations." Moebs tells banks it can help them increase their fee income by 200 percent.
The American Bankers Association says that the automated overdraft systems are just a "modern twist" on banks' traditional practice of paying overdrafts on a discretionary basis, adding that they assure more consistent treatment of customers. The largest bankers' organization is opposing legislation sponsored by Democratic Reps. Carolyn Maloney of New York and Barney Frank of Massachusetts that would make the loans subject to the Truth-in-Lending Act—so that a calculated interest rate would have to be disclosed on account statements. The ABA says such proposals would only confuse consumers and ultimately raise costs.
"Overdraft protection is an important service for our customers, and we believe customers should understand the responsibilities to track deposits and withdrawals, and any fees associated with overdrafts and options to avoid them," Nessa Feddis, the ABA's senior federal counsel, said in testimony prepared for a Wednesday House hearing on the issue. In other words, customers should keep a close eye on that checking account balance.
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