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Understanding Overdraft Fees

overdraft fees

If you spend more money than you have in your bank account, it becomes overdrawn. Banks penalize customers for overdrafts by charging fees which can take a toll on your funds and your peace of mind. In our blog, we take a deep dive into overdraft fees, their history, and how you can avoid them.

Overdraft Fees Definition

An overdraft occurs when a person spends more money than they have in their checking account. For example, a person has $20 in their checking account. To start their day, they purchase an $6 coffee and a $3 muffin. Then, they take the bus to work which has a $5 fare. Around noon, they decide to buy lunch from a café across the street that costs $15. The person has spent $29 and overdrafted their account by $9.

Once an account is overdrafted, the bank will allow the transaction to go through, but at a price: the overdraft fee. Depending on the bank, an overdraft fee can range from $30-50. So, the café lunch that overdrafted the person’s account actually costs around $45-65 including the overdraft fee.

A Brief History of Overdraft Fees

Overdraft fees are a cash cow for banks, but these institutions are not to blame for their invention and popularity. Like most economic shifting inventions, overdraft fees are the product of consumer demand. Before Wells Fargo, Bank of America, and JP Morgan Chase took over the banking world, consumers could only withdraw and deposit using checks.

Checks, though obscure these days, where the only way bank customers could pay for things without cash. Credit was less of a factor and for a transaction to go through, there had to be enough money in the person’s checking account. So, consumers had to make sure that there was enough money in their spending account at all times otherwise their checks would bounce, and the transaction would be denied.

For wealthier customers, this system was irritating as they had enough funds to back up their purchases. Even if they were short a few, they had enough in savings to make up the difference. So, banks chose to listen to their most valuable customers and searched for a new solution to banking.

Their solution was a courtesy system where the bank would allow its customers to purchase at their leisure for a small fee – an overdraft fee.

Overdraft Mechanics

When a consumer purchases beyond their checking account capacity, they are charged a fee. The courtesy fee for checks died with check popularity in the 1990s. Once banks realized that the digital banking format was taking over, overdraft fees evolved to apply to all virtual banking transactions. The fees also increased to a minimum average of $30.

Now, banks benefit from millions in overdraft fees every year. These financial institutions have overdrafts down to a science; they charge larger transactions first and then work their way down to the smallest charges. This has the benefit of letting consumers see their most expensive purchases go through while banks benefit from their forgetfulness when it comes to the small stuff. The overdraft system often leads consumers to a negative balance more quickly.

It is not illegal to do so, but manipulating the system is against federal law. Wells Fargo was caught manipulating the system by charging excessive overdraft fees and targeting lower income bank customers. This was deemed exploitative by the federal government and now banks must ask customers to accept overdrafts when signing up for an account and must notify the consumer that their account has been overdrafted before charging the fee.

Thankfully, these restrictions give consumers the chance to stop a transaction that may overdraft their account before it goes through. Overdraft fees can also be discharged in a chapter 7 bankruptcy filing.

Debt, Overdrafts, and Your Financial Future

Overdrafts can eat away at your finances until it becomes too much to handle. Many consumers struggling with debt feels as if they have nowhere to go. The Law Office of Seni Popat, P.C. believes that your financial future can be bright.

Contact our firm to find out more about your legal financial options.