Protect Yourself From Overdraft Protection
District writer Andrew Trotter admits he's not the most careful person when it comes to balancing a checkbook. After he bounced a couple of checks a year ago, his bank suggested he sign up for overdraft protection through a bank-issued credit-card. In his case, if there was not enough money in his account to cover a check, his credit card would automatically make a cash advance (rounded to the next $100) to his bank account. "I was encouraged to use this not just as a backstop but as a convenience so I could write checks without worrying about my balance (at least up to my credit-card max)," Trotter wrote me in an e-mail.
That seemed fine with him, in spite of a per-transfer fee of $10 because the card's overall interest rate was 7.9%. However, it was only after he used the card for $900 in overdraft protection that he learned the interest rate for cash-advances was 19.9%. What's more, he learned that his monthly payments are first used to pay off the lower-interest balance, which now stands at around $3,000. As he found in the fine print on the back of his bill: "We will allocate your payments in the manner we determine. In most instances we will allocate your payments to balances..with lower APRs [annual percentage rate] before balances with higher APRs. This will result in balances with lower APRs (such as new balances with promotional APR offers) being paid before any other existing balances."
So even though Trotter quickly paid back most of the $900, it went to the $3,000 debt. Until he pays all of that off, his $900 will be sitting there, collecting interest at a rate of 19.9 percent. "That's the real thing that galls me," he said on the telephone, eager to point out the pitfalls of using a credit-card for overdraft protection to other consumers.
Trotter is not alone. A new study by the Center for Responsible Lending, a nonprofit research and policy group whose goal is to eliminate abusive financial practices, says that overdraft protection may be a debt trap for many Americans, particularly repeat users.
Banks started offering overdraft protection to help customers who occasionally bounced a check. It's been a growing business for the banks, with the Center now estimating that checking-account customers pay more than $10.3 billion in overdraft loan fees every year. And most of that--$7.3 billion--is paid by repeat borrowers, the Center says. "A mere 16 percent of bank customers account for nearly three-quarters of all overdraft loans," it concluded from a telephone survey it conducted between October 2005 through January 2006 of 3,310 households.
The center said it found "some intriguing--and troubling--information:"
* The average non-repeat user of overdraft protection is 40 to 44 with a household income of $35,000 to $40,000. About 71 percent of non-repeat users own their own homes.
* The average repeat user is between 35 and 39 and has a household income of $30,000 to $35,000. About 61 percent of repeat users own their own homes. More are likely to be single and non-white.
The Center says the data suggests that overdraft protection "may exacerbate the income deficit problem by trapping these families in debt." So once they bounce a check, they end up paying high fees and interest rates that lead to more bounced checks--and more overdraft "protection." Among other things, the center called for greater disclosure and clearer warnings and a requirement that borrowers affirmatively and explicitly consent before they participate.
Let me hear about your experience with overdraft protection plans.
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