Payday loans have gotten a lot of bad press lately as state governments attempt to crack down on the “legal loansharking” outfits that make very short term loans with interest rates going as high as 500 percent. But a new study by Marc Anthony Fusaro, a professor of economics at East Carolina University, found that the overdraft loans given by banks these days make payday lenders look like a bargain. In their “bounce protection” programs, banks will cover checks and ATM withdrawals that exceed customers’ balances so they don’t incur fees from merchants for bounced checks. This “courtesy” service, which most customers never ask for, comes at a huge cost.
Insufficient fund fees have become a major cash cow for banks, particularly during the latest credit crisis. The Center for Responsible Lending has found that with an average fee of $34, overdraft protection loans generate more than $17 billion a year for banks. About half the fees are triggered when people use debt cards for a small purchase, which the bank allows even though they have no money in their account.
Fusaro looked at overdraft protection as a form of a short-term loan and found that people who occasionally bounce checks (between 1 and 10 times a year) pay interest rates exceeding 6,000 percent. Chronic bouncers in the study, who make up a small percentage of bank customers, paid more than $3,000 in fees annually for the privilege. The average size of the overdraft was pretty small, between $90 and $300. The most extreme case in the study was one poor soul who had a $3 overdraft outstanding for one day, which resulted in an intereste rate of 260,245 percent, a hefty surcharge for using a debt card for a latte.
While these small fees don’t translate into a ton of money for most consumers, they add up mightily for the banks, and over time, can help trap people in debt that’s hard to escape. The banks don’t make it easy, as they intentionally manipulate check-clearing to encourage people to bounce a lot of checks. (CRL says the software vendors who sell these systems to banks promise to increase revenue from overdraft fees by as much as 400 percent.)
Rep. Carolyn Maloney (D-NY) and Rep. Barney Frank (D-Mass.) introduced legislation last year that would put a halt to some of this by barring banks from manipulating check-clearing to increase fees and requiring banks to get written authorization from customers before enrolling them in the courtesy “protection” programs. The bill would also have required the banks to warn customers using debt cards that a purchase would trigger an overdraft fee, allowing them to cancel the purchase. Not surprisingly, the bill was shot down last fall by heavy lobbying from community bankers and appears to be going nowhere. Note to self: pay cash!