What You Need to Know About New Overdraft Rules

Editor’s note: This post is from partner site LowCards.com.

If you have a checking account, you now have a choice to make about overdraft protection. New Federal Reserve rules require banks to receive permission from each checking account customer before the bank provides overdraft protection for ATM and debit card transactions.

The change started July 1 for new customers and takes effect on Aug. 13 for existing customers. The rules do not cover checks or automatic bill payments–banks can still authorize and pay overdrafts for these transactions at their discretion and charge a fee.

An overdraft occurs when one does not have enough money in a checking account to pay for a transaction, but it is paid by the bank anyway. This service is a loan from the bank and it isn’t free. Banks charge a non-sufficient funds paid item fee (NSF) that is typically $30-$40. A fee is charged for each transaction paid in this manner.

Before the new rules, most banks automatically added courtesy overdraft protection to checking accounts with details and fees in the fine print. Some customers didn’t realize the high price of the fee until they incurred the charge.

Now that the rules are in effect, banks are aggressively encouraging their customers to opt-in and marketing the benefits of overdraft protection. This is revenue banks do not want to lose. In 2009, banks collected almost $38.5 billion in insufficient funds and overdraft fees, Moebs Services estimates.

“Banks have made a lot of money by allowing customers to spend or withdraw money that was not in their account. An overdrawn account can happen quickly with multiple transactions, even if they are small amounts,” says Bill Hardekopf of LowCards.com and author of The Credit Card Guidebook. “Sometimes, overdrafts can be caused by a number of things that are not in the consumer’s control: the timing of cash flow or payments, the delayed posting of a deposit, or the banks paying the biggest withdrawals first. A $5 purchase can trigger a $30-40 fee. Since the cashier doesn’t tell you it’s an overdraft, you don’t know there is a problem until it is too late.”

In response to the new regulations, Bank of America and Citi no longer allow debit card overdrafts. Bank of America customers can still sign up for a formal program to cover debit card overdrafts.

How to Opt Out of Overdraft Protection (or Opt In)

Many banks are currently sending out informational letters to customers that explain overdraft protection and how to enroll in the service. A consumer can mail in the enrollment form (the letter may include a postage-paid envelope), or sign up by phone, in person at your local branch or online.If you do not choose an option by August 13, you will automatically be opted out.

Opting out means that you do not want your bank to authorize and pay for debit card and ATM transactions when it appears there is not enough money in your account to cover the transaction. This may create a situation where your purchase is declined.

Opting in means that you do want your bank to cover debit card and ATM transactions when there may not be enough money in your account to cover the transaction. As a result, you will be charged an NSF paid item fee.

Read the Fine Print

Carefully read the notice that you receive from your bank. It should reveal the true costs and limits of overdraft protection.

  • The cost of overdraft may not end with the NSF paid-item fee. If your account remains overdrawn, you can receive additional fees. For example, if your account is overdrawn and continues with a negative balance for ten consecutive days, BBVA Compass charges a $25 extended overdraft fee. If the ending daily balance remains negative for 20 calendar days, another $25 extended overdraft fee will be charged. The BBVA Compass limits NSF fees to six per calendar day. The total of the negative balances and all fees and charges is due immediately.
  • Transactions aren’t processed in the order they occur. Banks can charge the items to your account in any order. They admit in the fine print that this can cause the available balance to be insufficient to pay one of more other items that otherwise could have been paid. This means the order the charges are paid can affect the total amount of overdraft and non-sufficient funds fees.
  • Even if you choose to opt-in, the payment of an item is discretionary. Banks will choose which transactions to cover. You can’t count on having overdraft protection when you need it.
  • If you opt in, you can cancel at any time. If you do not opt in, you can do so later.

Alternatives to a Standard Overdraft

Most banks offer cheaper alternatives to standard overdraft protection. These include a link to your savings account, a credit card, or a line of credit that will cover overdrawn transactions. There is still a fee each time you overdraw your account and your bank performs a transfer but it is typically $5-$10, much less than the standard overdraft fee. You must contact your bank to set up this alternative service, since it is not part of the opt in selection.

“This is a good time to assess how you monitor checking account. Set up a low balance alert that will notify you when your account is low. Online banking you can help avoid overdraft situations and help keep up with your account in real time,” says Hardekopf.

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  • Roxanne

    The credit union where I work has offered the over draft coverage you write about. The thing is, if an account overdraws, whether or not we cover the overdraft, there is a $25 fee for overdrawing an account. The main difference that is made to the member is that they don't have to pay another fee to the place they wrote the check or a second overdraft fee when the merchant runs the check through for a second time. The way the system is set up, if they use their debit card at a store, if they have the amount available, the transaction is considered good. Then if they came and withdrew the cash before the transaction came through, there may not be funds available. Since the payment has to go to the merchant that had the authorization, it is paid. It still cost the credit union the fees from the clearing house, so we lose that income. If the member drops out of sight and makes no deposits again, we are out the money they spent. I know of no credit union that clears largest to smallest or clears debits before running deposits. The real solution to the problem of unwanted banking fees is obvious: do not spend money you don't have, don't forget to balance your account on a daily basis so you know what you have and take the responsibility for your life. You can avoid most fees just by doing these simple things.