Monday, May 23, 2005

Overcharging for overdrafts?

If you are one of the few Americans lucky enough to have not overdrawn your bank account in the last several years, you may be surprised by what I am about to say.

Overdraft fees are big business.

Even if you have overdrawn, and are aware of the fee (frequently ranging from $25 to $35 per item, plus a daily fee up to $10) you still may not have realized just how big an income stream they are for banks. Many banks earn fully half of their revenue from fee income, of which overdraft charges are the majority.

Predictably enough, as fees have risen, so have consumer complaints.

One of the stickiest complaints rises from banks paying items against overdrawn accounts. Many consumer groups have asserted that a payment against an overdrawn account is essentially a loan, and that in many cases the fee charged is an effective annual percentage rate (APR) in excess of 100%. Such groups want overdraft fees made subject to usury laws limiting the APR that can be charged, and in Indiana this is already occurring.

This is problematic both on concept and implementation. Because overdraft charges tend to be a flat fee regardless of the amount of the overdrawn item, it is somewhat fallacious to look at the effective APR. Customers are charged the same amount whether the item is $10 or $1000 and whether they are overdrawn by $5 or $500. Firms in many other industries also charge fees which might be considered ususious by this standard. Late fees are standard practice for utilities, landlords, and cell phone providers, just to name a few. In any of these cases, a late fee charged may amount to an effective APR in excess of usury limits.

If overdraft fees are subjected to usury laws, banks have a very simple solution. If the item is returned unpaid due to insufficient funds, no loan can be construed and usury limits can not be made to apply. Banks can continue to charge the same fees, but would deny any item that overdraws an account by any amount. For most consumers this would be much worse than the current practice, because they will pay the same fee to the bank, plus the payee may charge them returned item and late payment fees.

The Federal Reserve presented a reasonable alternative solution Thursday, improving fee disclosure requirements under the Truth In Savings Act. The new requirements, which take effect on July 1, 2006, will now require banks to specify when opening accounts the kinds of transactions for which they might impose overdraft fees. They also require banks that promote the payment of overdrafts in ads to disclose in periodic statements the total fees for paying overdrafts and for returning items unpaid. Ads must disclose the types of transactions covered, the time period consumers have to cover overdrafts, and the circumstances when overdrafts will not be paid, and cannot call an overdraft service a line of credit.

Consumer advocates want overdrafts regulated under the more stringent Truth in Lending Act, forcing banks to call paid overdrafts a loan - its "true nature," as the Fed put it. The Fed said it may revisit this issue.

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