Traditional Banks

Bank Overdraft Solutions

Bank Overdraft Solutions

In general, an overdraft occurs when you attempt to withdraw funds from your checking account but do not have enough money in the account to cover the amount of the withdrawal.

Most depository institutions offer two overdraft solutions:

Standard overdraft coverage

Your bank will cover an overdraft transaction for a flat fee (median fee $35). The fee will be assessed each time you overdraw your checking account. If you do not resolve an overdraft promptly (within a certain number of days), you may be subject to additional fees (“sustained overdraft” fees). Further, banks may exclude certain transactions from overdraft coverage unless you request these transactions be covered.

Overdraft protection plan

Your bank links your checking account to a “protecting account” (e.g., a savings account or a special line of credit). When you overdraw your checking account, the bank simply taps your “protecting account” for the overdraft amount. Some banks still charge a service fee for this arrangement, but it tends to be less than the fees applicable to standard overdraft coverage.

According to a Federal Reserve rule that went into effect on July 1, 2010:

  • Banks cannot add new customers to overdraft protection programs without their consent; and further, existing customers on July 1, 2010, who were added to a program prior to this date, were released from the program and given the option of rejoining.

In effect, depository institutions must first get your permission to apply overdraft fees to debit card and ATM transactions (that is, you must “opt-in” for this service).

Before the rule change, banks automatically enrolled customers in standard overdraft coverage plans. If you preferred an overdraft protection plan, you had to ask the bank to switch your overdraft coverage; not all requests were honored.

The new “opt-in” rules apply only to debit card and ATM transactions. Your bank may continue to enroll you in standard overdraft coverage for checks and automatic bill-pay services (you may or may not be able to opt-out from automatic enrollment).

How does it work?

With standard overdraft coverage, a bank covers your overdraft for a flat fee (approximately $20 to $40).

  • Most banks limit the number of times an overdraft fee can be charged within a given time period. Further, if an overdraft is not resolved promptly (the bank repaid for the overdraft coverage), additional overdraft fees may be assessed.

Banking Services – Overdraft Solutions

Instead of standard overdraft coverage, you can choose an overdraft protection plan. With this arrangement, if you overdraw your account, your bank will tap the “protecting account” you designate to cover the overdraft. Depending upon the “protecting account” you designate, you may be charged a fee for overdraft protection, but most importantly, the bank will honor the request for payment, so you will not have to deal with payment requests declined for insufficient funds.

What does this cost?

With standard overdraft coverage, your bank will charge you a flat fee each time you overdraw your account. Some banks also may charge an additional fee if the account remains overdrawn after a certain period of time (such as 5 business days).

The flat fee generally ranges between $20 and $40. Additional fees charged on accounts that remain overdrawn (sometimes called “extended” or “sustained overdraft” fees) can average $5 to $10 a day.

To illustrate:

  • You overdraw your checking account by $100 on a debit-card transaction. 
  • You previously “opted-in” for the bank’s standard overdraft coverage. 
  • The bank charges a flat fee of $30 for each overdraft. 
  • The bank covers your $100 overdraft and charges you $30 for the service. 
  • You owe the bank the $100 overdraft, plus the $30 charge. 
  • The $30 charge represents a 30% rate on the overdraft amount. 

The bank may assess additional fees if the overdraft matter is not resolved promptly, because the bank has advanced you $100 to cover your overdraft. These additional fees can significantly increase the total cost of the overdraft.

With an overdraft protection plan, the bank simply charges you what amounts to a “service fee” each time you overdraw your checking account and the bank has to tap your “protecting account” to cover the shortfall. Because the money in the “protecting account” is your own money – not the bank’s, no loan is involved in this transaction. 

 Scenario 1 – Initial Overdraft with no Sustained Overdraft Charges  – $250.00

  • Amount of Single Overdraft – $250.00
  • Initial Charge for Single Overdraft – $35.00
  • 5 Days to Resolve Overdraft without Additional Charges
  • Annualized Index of Borrowing Cost – 1,022%

Scenario 2 –  Initial Overdraft with Sustained Overdraft Charges – $250.00 

  • Initial Charge for Single Overdraft $35.00
  • 5 Days to Resolve Overdraft without Additional Charges
  • Additional Daily Charge for Sustained Overdraft – $9.00
  • 9 Days (the maximum allowed) for Sustained Overdraft Charges – 72.00
  • Maximum Total Overdraft Charge – $107.00
  • Annualized Index of Borrowing Cost- 1115.9%
Banking Advance Deposit Loans

 Banking Advance Deposit Loans

Advance deposit loans – also known as “checking account advance” loans and “direct deposit advance” loans – allow a bank customer to borrow against the customer’s next paycheck, Social Security check, unemployment benefit or other eligible deposits that are directly deposited into their account. In effect, a customer gains access to short-term advances against future bank deposits.

  • The loan is due in full when the next “eligible” deposit comes into the bank.
  • To use this type of loan, a bank customer must have a bank account coded to receive periodic direct deposits. A bank simply will debit a customer’s account to repay a loan which includes principal and applicable charges.
  • Banks promote advance deposit loans as an alternative to “payday lenders.” We should note that relatively few banks offer advance deposit loans.
  • In a March 2005 revision to banking guidelines, the FDIC allowed member banks to offer “payday loans” (although they were not called that). The FDIC wanted to ensure that this “high-cost, short-term credit product is not provided repeatedly to customers with longer-term credit needs.” The guidelines seek to limit the number of advance deposit loans banks can make per customer per year. The guidelines also discourage banks from making loans of this sort to customers with short-term consumer loans outstanding from other lenders for more than three months during any twelve-month period.

How does it work?

A customer opens a bank deposit account and schedules certain income payments for direct deposit (such as paychecks and government benefit payments).

  • Most banks do not require a separate application for an advance deposit loan. However, they do require a previously established personal checking account. You enroll in a bank’s advance deposit loan program by visiting a local branch or enrolling online or through an ATM.
  • As an existing customer, when you complete enrollment, you are eligible to borrow. Once you take an advance, funds are available to you right away (no delay).
  • Banks routinely enforce a maximum advance amount (credit limit).
  • Because advance deposit loans are short-term credit vehicles, you can expect banks to limit the repayment period (a common limit is 30 days with a maximum of 35 days).
  • Banks can be expected to caution customers who use advance deposit loans that these loans represent an expensive form of credit and should be used only to address shorter-term borrowing needs. Customers are advised to borrow only amounts they can afford to pay back from their next direct deposits.
  • Early repayment will cause the cost of the loan to rise. The fee that was charged remains the same regardless of when the loan is repaid

Banking Services – Advance Deposit Loans

Late repayment of an advance may cause an overdraft in the customer’s checking account, which may trigger penalty fees.

What does it cost?

Banks that offer advance deposit loans tend to use a similar pricing strategy. 

  • Once you enroll in an advance deposit loan program, you can request an advance at any time against the funds to be deposited in your account on the next deposit cycle.
  • The required repayment period usually is about a month. Because repayment in full typically is required by the next account deposit, even a small transaction fee can produce a high annualized borrowing cost. Notable features may include:
    • The amount of an advance plus applicable transaction fees will be deducted by the bank at the time of a customer’s next deposit of $100 or more. 

If a customer fails to repay the advance and applicable fees by the 35th day, the bank can deduct the full repayment amount from the customer’s account using what the bank terms “automatic repayment.”

If the automatic repayment of a past-due advance overdraws the account, the bank can assess standard overdraft charges, unless the customer has some form of overdraft protection plan in place. 

For repayments that exceed the banks repayment time limit, additional fees may apply. 

  • The interest rate on advance deposit loans is usually a dollar charge per $100 of loan amount. This charge is called a transaction fee or cash advance fee.
  • Most banks charge a single fee on advance transactions. Among banks that make these transactions, the typical fee is $8-$10 per each $100 advanced.

Using this fee as an example, a 30-day advance represents a periodic interest rate of 10% and an annualized index of borrowing cost of 120%. A 14-day advance would represent a much larger annualized index of borrowing cost (approximately 261%).

It is interesting to note that for some banks, whether repayment is made one day after the advance or 35 days later, the fee does not change. In the preceding example, a 10% fee assessed for only one day would produce an annualized index of borrowing cost of 3,650%.

While banks do not differ much with respect to transaction fees, eligibility requirements and limits on the number, frequency, and amount of advances do vary among banks.

Some banks consider an advance a withdrawal against a line of credit, and not a loan. They contend that a bank is subject to negligible risk that an advance will not be repaid from a customer’s next deposit (or the customer’s full account if repayment is past-due). Still, the advance is secured by the customer’s account (and future deposits), much like a bank loan with collateral.