Automatic Overdraft Services – Convenient or Excessive?

Your bank calls it a “convenient service” and a “safety net”. Your bank tells you that with this service it is easy to make sure your debit card transactions are “covered”. After looking into a recent offer for Automatic Overdraft Services from a large bank, I had to ask - what is the difference between the fees charged for Automatic Overdraft Services and the fees charged for a payday loan?

Consumer advocates have targeted the payday loan industry criticizing payday loans as predatory with fees that equate to usurious interest rates. A number of states prohibit payday loans, other states cap the fees or interest rates allowed on payday loans and the new federal Consumer Protection bureau will be crafting new regulations for the payday loan industry. But a number of commentators believe payday lenders provide critical services to "credit-underserved" consumers who need credit for emergency expenses like a car repair bill, a dental bill or past due rent, credit that is often not available through traditional lenders.

The Automatic Overdraft Services (sometimes referred to as a Debit Card Advance) banks are offering can help a consumer with short-term, time-sensitive expenses very much like a payday loan. The consumer pays a fee for each use of the Automatic Overdraft Service rather than interest rate.

Recently a friend showed me an Automatic Overdraft Service offer she received from a large, well-known bank. The first thing that caught my eye was that the bank charges a $35 fee per overdrawn transaction up to a maximum of 5 per day. This means a customer could overdraw her bank account for a $300 car repair or for a $40 tank of gas in a single transaction and pay the same $35 fee for the single overdraft.

Thinking that perhaps I was missing something here, I placed a call to the bank asking about the typical limit available for a debit card advance. My first thought was that the typical limit would be a couple thousand dollars, making the fees seem more proportionate to the amount borrowed. However I found that the limit typically ranges between $300 and $900, depending on the applicant’s credit score, banking history, and other factors.

In addition, the bank also charges a one-time fee of $20 each time your account is overdrawn for 10 consecutive business days. Ten consecutive business days? Ironic that they give a customer 10 consecutive business days to pay off the debt before adding another fee, as most people have a Payday every 10 business days. Payday loans typically follow that same schedule.

So imagine I had five separate overdraft transactions in a single day (for this thought experiment, let’s say each overdraft was $40 dollars - 5 tanks of gas because of an emergency road trip to care for my sick mother - for a total of $200 in overdrafts); my bank fees for that $200 overdraft would add up to $175.

If I had taken out one payday loan for $200 in a single transaction for my last minute emergency trip, it would have cost me roughly $35 dollars. Consumer advocates would say it cost me an interest rate of 639%. Instead, with the convenience of my debit card with Automatic Overdraft Services, the $200 short term loan would cost me $175 dollars, or an interest rate of 3194%.

Of course, the payday loan could cost me a lot more than $35 if I don’t pay it back within the 10 days. The bottom line is that it doesn’t take a banking expert to see that an Automatic Overdraft Service can be costly if a consumer isn’t careful. In states where a payday loan is not available, this option could become an expensive alternative for the credit-underserved consumer.