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Tom: This morning you join us to talk about overdraft charges.

Mellody: I do, because this is a very big issue many people are confronted with every month. A number of banks hit people with charges or fees when they overdraw their accounts, and in many cases account holders find themselves in a very vicious cycle. There are a number of options that I want to talk about this morning so that listeners have an idea of what they are confronted with, the difference between each one, and how to avoid the worst options, even if the best choice is to not overdraw your account to begin with.

Tom: What are the different ways that you can be charged for overdrawing your account?

Mellody: There are four main types of overdraft fees you will see. The first, and easily the least troublesome, is a non-sufficient funds fee. This is when you do not have enough money for a transaction, it is declined, and you are charged a fee. The second type is called is called bounce coverage or courtesy overdraft protection. These plans are often offered automatically to ensure your charge goes through, and many of them include a fee on any overdraw on your account.

The third type is a linked credit card. Here, your bank allows you to link your credit card to your account, and if an overdraft occurs, the amount of your purchase beyond your checking balance will be charged to your credit card. Finally, a number of banks offer overdraft lines of credit, where the customer is offered a line of credit specifically to cover any checking account overdrafts. Almost all of these options will have fees or charges associated with them.

Tom: What makes these kinds of services so troubling? 

Mellody: A recent article in the New York Times highlighted two of the biggest problems with these fees; many consumers do not know they are signing up for them, and these plans can result in a very vicious cycle of ever greater fees. On this first point, it is very common that when you go to open a new account, you are offered overdraft protection. What is not common is that the type of protection is always explained. And because of the fact that many of us want to avoid bouncing a check or getting a transaction turned down with a card, we readily accept.

The problem is that there is not a lot of transparency around these fees. Since federal bank reform became law in 2010, banks are prohibited from enrolling a consumer in an overdraft program — and charging the fees that can result — unless the consumer opts in. But studies have found that more that half of consumers who end up paying these charges don’t remember opting in. The second problem is that they often snowball. Whether it is the average $35 bounce coverage, or the more problematic line of credit charge, many people – especially those living on a tight budget – incur these fees and then get trapped, causing people to end up paying hundreds or even thousands of extra dollars because of $5 or $25 dollar overages on their account.

Tom: Why are banks employing these fees so aggressively?

Mellody: The short answer: money. Under a recent rule implemented by the Consumer Financial Protection Bureau, banks with more than $1 billion in assets now need to report on how much revenue they bring in from overdraft fees and other charges. The first report found that these banks made $11.6 billion last year from customers who overdrew their accounts. According to the CFPB, the 594 banks subject to the rule made 8% of their revenue on average from these fees, and these fees accounted for 65.3% of all reported consumer deposit account fee revenues.

Tom: How can account holders avoid these charges?

Mellody: Obviously, the easiest way to avoid these charges is not overdraw your account. There are a number of tools to help you monitor your balances, like text alerts or mobile banking or budgeting apps. The second thing I recommend is speaking with your bank about your current account rules, or reading the fine print if opening a new account, and opting out of any coverage that allows overdraft fees on a transaction or line of credit. Instead, it is better to get a one time non-sufficient funds charge than racking up repeated overdraft fees if your balance goes in the red and is left unpaid for days or weeks.

Another good option if you are worried about these charges is to link it to a second account, like a savings account. When necessary, your bank will transfer money from that savings account to cover a purchase. You may incur a fee, but it’s much smaller than an overdraft or NSF fee. You make this a habit! Your savings are sacred, so this should be rare, and only happen because its better than overdraft charges. Finally, you can consider a prepaid debit card. These cards don’t link to checking accounts, they require you to add money before you use them. Prepaid debit cards generally don’t incur overdraft fees, but some may charge for declined transactions. If you can find a prepaid card without these fees, they are a good way to avoid overdraft and related costs.

Tom: Always great advice. Thanks for joining us, Mellody.

Mellody: Have a great week, Tom.

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