Overdraft Protection (6/14/05)

I'm aware that my Banker's Story doesn't always pertain to everyone. And, hopefully this one pertains to very few of you. I've had several inquiries over the years regarding overdraft situations, whether by bank error or account holder error. Therefore, I thought I'd address a few ways to avoid overdrafts and how to deal with them once they occur.

We've all been overdrawn before, or "bounced" a check. I know millionaires who overdraw their account every month. Most of the time, it's not because they don't have the money, it's because they weren't keeping track of their balance. Things like automatic debits and debit cards are making it more difficult for people to keep a tally on their monthly expenses.

Over the last decade, banks have come up with several ways to avoid overdrafts by offering new services to help customers keep track of their accounts. You're probably familiar with 24-hour account information hotlines, or online banking services. Most banks offer these services for free. However, some banks require a minimum balance to obtain their online services for free. Other banks may charge or have usage restrictions. Either way, if your bank offers this service for free, use it. You can typically sign up for the services via the internet without having to visit a local branch. The 24-hour account information lines, or VRU (voice response units) are a little old fashioned for today's technology. However, if you're not a computer user, this is the only other way to obtain your account information before your statement arrives.

Online Banking
You can view your account information 24 hours a day, 7 days a week from anywhere in the world. Most online services even allow you to view a copy of a recent check. In the event you forget to write down a transaction in your register, you could view copy of it online (Adobe Acrobat is necessary for this function in most cases). Please keep in mind that the bank only knows what has cleared your account. Because of this, the balance you see online is rarely the actual balance in your account, because it doesn't take into consideration the transactions you've made which haven't cleared yet. I know this sounds pretty elementary to most of you, but I've had to make this distinction on many occasions with customers. In the end, online banking is a great tool to utilize in the war against overdrafts, especially if you're not a meticulous record keeper or you're the type of person that doesn't balance their checkbook each month.

Overdraft Protection
Most banks have products available they refer to as overdraft protection. Be sure to read the fine print when signing up for these products. Banks don't like to hand out "get-out-of-jail-free" cards for nothing. I'll give you three primary forms of overdraft protection that are most common.

Credit Card: At Commerce Bank, you can obtain a credit card and tie this card to your account. In the event your account becomes overdrawn, cash advances will be charged to your card in $50 increments to cover the overdraft. You won't receive any overdraft fees, but there will be a small cash advance fee (3% of the advance) as well as finance charges on the credit card if the balance isn't paid off.

Savings transfer: I know of two banks that have this option. This form of overdraft protection allows you to tie your checking account and savings account together so in the instance of an overdraft, funds are automatically transferred to your checking. There's a small fee assessed each time this transfer occurs.

Line of Credit: This form of overdraft protection allows you to tie your checking account to a line of credit set up at the bank which will be triggered when an overdraft occurs. Again, interest will be charged at the time the overdraft occurs. Regular lines of credit or home equity lines of credit can typically be used.

Although there are fees or charges for these services, they may save you money if you tend to overdraw your account on a regular basis. Overdraft fees are typically much higher. Or, in many cases, you aren't charged anything if you don't use the service as it costs nothing to set up. You may want to look into something like this for preventative measures.

Now, what happens when an overdraft situation occurs?
At most banks, there's an operations department that monitors an overdraft report each morning. At this time, a decision is made to either return the item that's overdrawing the account and charge a fee, or pay the item (even though it overdraws the account) and charge a fee. Most of the time, these decisions are automated. For example, if you're overdrawn by less that $100, the system will typically pay the item if your account doesn't have any negative history with regards to overdrafts. If an account has a bad history of overdrafts, the system will typically return all items regardless of the negative balance. The system doesn't pay attention to the specific item which is overdrawing the account. For example, the system won't decide to pay your mortgage, but not your debit to Wal-Mart. It doesn't matter if a check is clearing the account or an automatic debit. The decisions are made based on the account activity. At the time of an overdraft, a notice will be mailed to you indicating the fate of your overdraft item and the fees assessed to your account.

If an overdraft item is paid, the merchant will never know that your account was overdrawn. If items are returned, you have a larger problem. Some merchants will send your check through a second time to be paid. Some merchants will not. In this event, you'll need to contact the payee to inform them of the situation. If you bounce a check written to an individual, they will receive the check back from the bank as a "returned deposited item". At this point, you should probably write them another check (if they will accept another check from you at this point). If items are returned due to a bank error, the bank should furnish a written letter of explanation and help you rectify the situation, including waiving all overdraft fees and assuming the fees charged to you by the merchants who received a bad check.

Fees and Repercussions
The fees for an overdraft are typically $15 to $30 per item. Some banks have implemented an increasing fee scale. For example, your first overdraft offense may be $15 per item, and increase $5 for each additional offense (with a maximum fee, or course). These fees are debited directly from your account. It's important to note that having an overdraft DOES NOT effect your credit report or credit rating. Banks do not report overdrafts to any outside agency. The only time an overdraft can really hurt you from a long-term standpoint is when an account is left overdrawn for greater than 30 days. If an account remains negative for greater than 30 days, most banks will close the account and "write off" the negative balance as a loss and report the customer to a national company called Chexsystems. You may have heard of this company because all banks run your name and social security number through this service before opening an account for you. In a nutshell, it can tell banks if you're a good account holder. If you ever get reported to Chexsystems, good luck getting out of their system. I've had customers spill their guts to me about how they ran out of cash and had to skip town. And, after paying the bank back for the loss that was incurred, they still were unable to clear their name from Chexsytems. It's a monkey you'll carry on your back for seven years. Therefore, if you're ever overdrawn, be sure to rectify, quickly.

Having an overdraft is no big deal. Having repeated overdrafts is a large problem that you'll need to address. The fees will eat you alive. I've seen customers with hundreds of dollars in overdraft fees. Banks make a lot of money from these fees, and justifiably so as there are easy ways and inexpensive ways to avoid these mishaps. Feel free to contact me if you have any questions.