Avoid Overdraft Protection Loans

Hi All,

So, my wife Miel and I were at our local BB&T branch a couple of weeks ago. We were adding her to the safety deposit box I had opened. While we were going through the paperwork, the banking rep took the opportunity to pitch us on overdraft protection for our checking accounts.

I waffled. While I didn’t want to criticize BB&Ts products directly in front of a BB&T rep, I generally think that overdraft protection – in particular overdraft loans – are nonsense. Here is why:

1) It’s not protection for you, its revenue for the bank. Often, overdraft protection arrangements are loan agreements whereby they cover any expenditures made in excess of account deposit balances. Typically these sorts of loan arrangements carry annual fees and interest rates of 12 to 18%.

Something like 46% of people overdraw their accounts due to excessively liberal use of ATM cards (1). That is, they just make too many withdrawals. Typically, it’s a bunch of small transactions, 5 buck lattes, $40 at the ATM, 10 dollars for Chinese food, stuff like that. What this means is, for a bunch of small transaction, the consumer gets slapped with 18%.

Think about it, is it in your best interest to pay a percentage on money you don’t have? On the other hand, banks can make 12 to 18 percent with the overdraft product. When considered this way, it becomes clear that overdraft loans aren’t really protection for you, they’re money for the bank. Bank revenue numbers support this. In 2007 the banking industry made 17.5 billion on overdraft fees (1). Use the cash to build your wealth instead and you will be much better off.

2) There are better alternatives. The high cost of overdraft protection loans means you probably should think about alternatives. These include:

A) Linking checking to a savings account. Usually there is a modest transfer fee, something like $5 dollars. But, this is certainly better than an annual fee and 12-18% interest.

B) Better account management. If you are using overdraft protection more than once in a while, it probably means that something is wrong with your cash flow management. Instead, it might make sense to think about ways to improve your cash arrangements. These could include a paper register for your transactions or increasing your use of paper money.

For more on this topic check out Wisebread’s posting – it’s got Ralph Nader (WB).

Thanks,

James