Overdraft protection -- worth the price?
By Michelle Samaad • Bankrate.com

Between back-and-forth trips to the ATM and point-of-sale transactions that give you cash back, keeping a handle on your money can become a game of "guess the amount in the checking account."

Add to that game rising fees for bouncing a check -- up to $32 -- and the stiff fees charged by the merchant receiving the rubber check.

Don't pout yet. We're human and one bounced check every now and then is common. But if your monthly account statement shows more than that, it may be time to get disciplined: Keep better records, balance more often -- or consider using a tool such as overdraft protection.

Protection comes in three forms, depending on where you bank: through a credit line, savings account or credit card account.

Moving money around
The most popular style of the service requires the customer to establish a line of credit -- usually up to $5,000 -- from a separate account. Money from that other account can then be used to pad a checking account that doesn't have enough money to cover a check. When you sign up for the service, the bank or credit union automatically transfers money to your checking account upon spotting a check that exceeds the account balance.

While this type of service means avoiding a fee for a bounced check, interest rates on these lines can run 18 percent or more. Some banks tack on annual fees of $15 to $20.

A few lenders, including San Francisco-based Bank of America, automatically shift money from your savings account to your checking account to cover overdrafts. But shop around, because the fee to cover each overdrawn check ranges from $5 to $25. Although the customer pays no interest on the money transferred, the money stops earning interest when it leaves the savings account.

Another version of the service links the protection with a credit card. A number of banks, including PNC Bank in Pittsburgh and San Francisco-based Wells Fargo Bank, link a customer's checking account to a credit card. When a pending overdraft is sighted, the bank posts a cash advance from the credit card to cover the shortfall. The customer ends up paying interest on the money borrowed and, in most cases, a cash-advance fee of about 2 percent.

Still liable for interest
With both credit card-linked services, put back doesn't always mean paid back. Even if enough money is deposited into the checking account to cover the overdraft the day after it occurred, the account holder would continue to pay interest on the personal credit line until the account is settled. Many banks transfer money to a checking account only in increments of $50 or $100.

That means if you overdraw just $10, your bank could deposit as much as $100 into your account. In the case of a plan charging 18 percent interest, you could pay $1.50 or more in interest and fees per day on a $100 overdraft.

The downside to overdraft protection is clearly the cost, which includes:

• Monthly or annual fees
• Fees for transferring money between accounts
• Interest owed on the borrowed money

There are numerous ways to lose track of check writing and overdraw your account. With the introduction of the debit card -- a credit card of sorts that draws money from a checking account -- tracking spending can be even more onerous.

To some, overdraft protection creates a buffer zone. "It's getting harder and harder, especially for people with joint accounts, to keep track of an account balance because there are so many variables beyond just paper checks," says Jean Ann Fox, director of consumer protection for the Consumer Federation of America in Washington, D.C.

Conscious of your balance
The best way to prevent an overdrawn account? Be alert to what's being spent every day.

"If you are going to be a heavy debit-card user, you have to get compulsive about record-keeping," advises Marilyn Nall, a counselor at the Consumer Credit Counseling Service of Maryland and Delaware Inc. based in Baltimore.

Given the more than 125 million checks that are bounced each year, some banking experts estimate that nearly half of the people who have overdraft protection make use of the service every month.

But "banks have the discretion to decide whether to return a check for insufficient funds or cover it until the customer makes good," says Fritz Elmendorf, vice president of communications for the Consumer Bankers Association, an Arlington, Va.- based trade group representing retail banks. "The rules on when a check will be bounced and when it will be covered aren't the same at every bank or even for every customer."

Not surprisingly, small-town banks tend to be more flexible and charge lower fees for overdrafts and returned checks, according to a survey by Sheshunoff Information Services, an Austin, Texas-based research firm that tracks banking industry data.

The cost of bouncing
Similar to other banking fees, overdraft charges have gone up during the past few years as banks have boosted their charges to make up for losses on bad loans. Overdraft fees average about $12 a check, according to the study, but in bigger cities such as Washington, $25 fees have become common.

In addition, companies that receive bad checks are likely to charge the bank customer a fee, too. How much? That depends on who received the bounced check. Retailers tend to mimic bank charges, with bounced check fees ranging from $10 to $25. But if you write a bad check to your mortgage company, you might be hit with a late payment fee of $50 or more.

That's what happened to Kendall Williams, a field operations engineer for Nortel Networks. The Chicago native wrote a check for his car loan, but he didn't have enough money in his account to cover the check and he didn't have overdraft protection. So his bank charged him a $30 late fee, which then caused his telephone bill to bounce. Luckily, because of his "excellent" car-payment history, his lender didn't penalize him for the check.

"I had only bounced a check once and that was during my freshman year in college, so it was sort of a double-whammy to get the late fee and the bounced check for my phone bill," Williams recalls.

That was a year ago. Today, Williams uses an overdraft protection service at his bank "just in case."

Make good soon
The best way to avoid service charges on overdraft protection is by not waiting for your monthly statement to arrive, Nall advises. "Call your banker right away to verify the amount needed to repay the entire advance, and pay it off as promptly as possible," she says.

As much as it sounds like a broken record, customers also should avoid bouncing checks in the first place by balancing their checkbook regularly "so you can keep an eye on the bottom line," says Fox of the Consumer Federation of America.

Also, immediately deduct from the checking account balance for automated teller machine withdrawals, bank fees and debit card purchases at stores.

Consumers should also assess their spending habits and budgeting skills. For instance, does keeping track of where the money goes each month equate to a day at the dentist -- painful? Or is every penny that leaves the checking account tracked and accounted for each month?

"Your answer will be a strong gauge in deciding whether overdraft protection is the way to go," Fox says.

Before signing up for overdraft protection, ask the following questions:

• What is the interest rate? Banks and credit unions charge from 10 percent to 18 percent for overdrafts.
• What is the transaction charge? Some financial institutions charge a fee for each transaction in addition to regular interest rates.
• What is the advance amount? Some make overdraft advances either for the exact amount or in multiples. Therefore, if the bank loans only in multiples of $100, you would have to borrow $100 (and pay interest on it) even though you only wanted $10.
• What is the monthly fee? There might be a monthly fee in addition to interest.
• How does paying off the overdraft work? Find out if deposits to your checking account automatically apply to an overdraft balance or if you must specifically repay the loan.

Overdraft protection can be a preventive service, but the key when it comes to budgeting is to use discipline.

"It's a safety net, but does it really teach us how to keep track of our spending? Probably not," Nall says. "We should always know how much money is in our checking account and who's been paid."

-- Posted: May 24, 1999