Hot Button: Checks and Balance

Banks are getting out of the business of forcing overdraft protection on their customers. Will that

Checks and Balance
Thanks to a particular high-volume coffee retailer and a piece of plastic that eliminates the need to fumble for cash, the morning latte that Seattle made famous has gone from luxury indulgence to routine convenience. But is that convenient indulgence worth the $35 you could end up paying for it?

The “$35 latte” is a term financial-literacy experts use to drive home the cost of an expensive bad habit many consumers have acquired: incurring overdraft protection fees on debit and ATM card transactions—which can amount to $30 or more each time they “bounce” a figurative check.

If consumers have shrugged off the accumulation of such fees to date, they finally have to confront the issue because of new banking-industry rule changes. The Federal Reserve regulations now require that consumers be given an “opt in” choice of overdraft protection for new accounts opened after July 1, and for existing accounts after Aug. 15. For those who don’t sign up for overdraft protection, ATM and debit card transactions will be rejected if there’s not enough money in their accounts to cover the purchase.
What this means is that banks in Seattle and across the country will no longer be allowed to automatically sign up their checking account customers for overdraft protection—and automatically bill them every time they spend more than the balance available in their accounts. Instead, banks will be required to ask customers if they want overdraft protection: If the customers don’t, they won’t be able to complete a transaction if they’re overdrawn, but they also won’t get socked with the “protection” fee.

Seattle resident Jack Bishop (not his real name) racked up an impressive array of such fees last year when he inadvertently drained his checking account. He thought he had transferred money online from a money market account into his checking account to cover expenses, but he mistakenly did the opposite by transposing the account numbers. He didn’t notice his error for several days, at which point he had been dinged several times by his bank’s overdraft-protection sentries.

When he called his local branch of HomeSteet Bank and “pleaded stupidity,” Bishop says the bank forgave the overdraft fees and explained to him that he could easily have his checking account “linked” to his money market account as backup, in case he ever overdrew his checking account again.
“No one had told me that before,” he said, “and it didn’t occur to me to ask.”

Bishop’s solution eliminates the need for overdraft protection. But if he didn’t have his money market account to fall back on, he says he would still appreciate the opportunity to opt in to such a program.
“It’s essentially a trade-off between being humiliated at the cash register and being surprised when your bank statement arrives,” he says. “I’d rather not be embarrassed at the register.”

The issue of overdraft protection has been a hugely controversial one, with consumer advocates accusing banks of predatory and abusive practices ranging from poor disclosure to charging overdraft fees that have no relationship to the actual cost of handling an overdraft transaction, to processing transactions in such a way as to trigger the fees. The dispute has spilled over into the courts, legislative forums, the regulatory arena, even shareholder meetings of publicly traded banks, where resolutions on the topic are on the proxy ballot.

Beyond the issue of banking practices and regulation, which in itself is a fight with billions of dollars at stake, there is the larger question that is germane to the current financial meltdown: Don’t people know how to manage their money anymore? It’s not that people weren’t able to get themselves into financial trouble long before the spread of overdraft protection. Consumers have proven perfectly adept at racking up huge credit bills and writing rubber checks. But the proliferation of debit and ATM cards opened new possibilities for spending more than we have.

“We think of this as so normal now,” says Denise Rodriguez, community outreach director for the Bellevue office of Apprisen Financial Advocates (formerly Consumer Counseling Northwest). She says overdraft protection provisions are fairly recent. “It used to be if you used your debit card [for more than was in the account], you would be turned down.”

That was one reason banks began offering overdraft protection, she says, as a sort of courtesy. Of course, the banks were doing well by supposedly doing good. Overdraft fees generated nearly $24 billion in 2008, the Consumer Federation of America reports.

That added fee income came in handy as banks found themselves pressured by competition to offer more “free” checking accounts that didn’t charge monthly service fees. (One consequence of the rule change on overdraft fees, Rodriguez conjectures, is that banks may go back to a fee system on their checking accounts.)

Some consumers quickly came to find the overdraft protection an expensive bit of credit. Rodriguez says those who tripped up on overdraft fees tended to fall into two categories. There were those who triggered an overdraft charge occasionally, perhaps because they didn’t update their checking account balances or forgot a recent transaction that dropped their balances below the amount of the intended purchase. And then there were the habitual offenders.

“More often we see people who are repeat overdrafters,” says Rodriguez. “They don’t have a good tracking system. They end up paying a lot of fees.”

Those fees often landed on people already living paycheck to paycheck, with little financial cushion to start with; the accumulation of fees just added to the problem. Also exacerbating the issue are the sloppy money-management behaviors consumers fell into as a result of the wonders of electronic banking. Those who bothered to check at all often relied on the balances displayed on an ATM screen or via an online account statement. As Amy O’Donnell, president of a financial literacy group called the Washington Jump$tart Washington Coalition, says, “You may not think to account for something that’s waiting for approval. If you think you have $75 in your account, but there’s a check out for $25, you really only have $50.”

At a time when purchases are made by swiping plastic through a card reader rather than writing a check or handing over currency, O’Donnell says consumers are less adept at keeping track. “They’re not necessarily getting information about how to balance a checkbook,” she says. “It’s very easy to overspend.”

Being a better money manager isn’t impossible. “People can learn that skill,” Rodriguez says. Consumers may also have some of those skills thrust upon them, since some banks may decide to ditch overdraft protection altogether. Bank of America, the largest bank doing business in Washington, announced it will only authorize a debit card transaction if there’s enough money in the customer’s account; customers can still get a form of overdraft protection by linking their checking account to another account—as Jack Bishop did—so funds can be drawn to cover the excess amount.

Other banks are bolstering the information consumers get about their account status. JPMorgan Chase (which took over the former Washington Mutual) now offers immediate text messages to its customers when accounts fall below specific balance amounts they’ve selected. Customers can also send text messages back to transfer funds into checking.

Useful as these measures might be, people in the consumer-finance education business say education and changes in financial behavior remain crucial.

“It’s part of the reason why we’re in this [national economic] situation,” Rodriguez says. “We’re borrowing against money we don’t have. Hopefully, this will teach people to live within their means.”

A program designed to help people do just that, called Bank on Seattle-King County, is steering consumers, especially low-income people, toward basic banking services and away from check-cashing services. Diana Stone, director of initiatives with the Seattle-King County Asset Building Collaborative (one of the program’s sponsors), says a big reason why some people avoid traditional banks and banking accounts is that so many unexpected fees—such as overdraft protection—seem to pop up. While the change in the overdraft-protection regulation is great, Stone worries that people could wind up in even greater financial peril “if you haven’t been educated about how to be successful with a bank account.”

O’Donnell adds: “My hope is that, culturally, we have more of these conversations around financial education, [such as] ‘What are the basics you need to know? How do you access that information before you run into trouble?’ We’re getting better at it.”

We’d better hope so. If people are denied overdraft protection but don’t reform their spending, they’ll just go back to putting purchases on plastic credit. Which will make the $35 latte start to look like a real bargain in the final accounting.

Originally published in August 2010