checking

Bank overdraft protection: Do you need it?

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Highlights
  • As of Aug. 15, if you want overdraft protection, you must sign up for it.
  • With overdraft penalties, you can rack up hefty fines for lack of funds.
  • There are pros and cons for receiving bank overdraft protection.

Remember to wear black Aug. 15, because that's the day the infamous $35 latte may finally meet its demise. From that day forward, a new Federal Reserve rule will prohibit banks from charging overdraft protection fees unless a customer opts in.

Overdraft protection is a service offered by banks that allows checking account holders to temporarily make purchases with a debit card even if they don't have sufficient funds in their account to cover them. In effect, the bank makes a short-term loan to the account holder so his debit card isn't declined at the register or an ATM machine. In return, the bank charges an overdraft fee of $10 to $35, according to an informal Bankrate survey.

"(The new law) puts the decision in the hands of the consumer as to whether they want overdraft protection for small-dollar transactions conducted by ATM and debit card," says Greg McBride, CFA and Bankrate's senior economic analyst.

However, the law doesn't correct a consumer's underlying spending habits, McBride says.

"It doesn't relieve consumers of the obligation to keep accurate tabs on their account balance," McBride says. "Even though an ATM or debit card transaction won't go through without our prior consent, if the balance is that low, the check written yesterday won't clear and the online payment scheduled for tomorrow won't clear."

Contentious history

Overdraft protection became infamous with consumer advocates because consumers were often automatically enrolled in the programs without their knowledge and may have wrongly assumed that if they didn't have the money to make a purchase, it would be declined.

"A lot of people use their debit cards several times a day, so you could easily rack up hundreds of dollars worth of fees," says Leslie Parrish, senior researcher at the Center for Responsible Lending, in North Carolina.

And at an average of $27, according to Moebs $ervices, an economic research firm based in Lake Bluff, Ill., the fees were often much higher than the offending purchases, which averaged just $16, according to Parrish.

Still, it's important to keep in mind that some banks' and credit unions' overdraft protection programs have better terms than others. Everything from per-transaction fees to limits on how many fees can be assessed in one day vary greatly by institution.

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For instance, Chase charges a $34 fee every time it covers a purchase you can't. In contrast, SAFE Credit Union, based in California, charges a $27, but waives fees for purchases less than $25 and only assesses the fee once a day, no matter how many purchases you make.

To opt in or not?

The Aug. 15 change is bad news for banks; the overdraft fees generated $37.1 billion in 2009, according to Moebs.

"(Banks) make a huge amount of money on this," says Dean Baker, co-director of the Center for Economic and Policy Research.

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