End of the road for overdrafts?

In college, I once bought a $3 toothbrush from a corner store. Two days later, I realized this little marvel of hygienic equipment cost me $38. If I’m paying that much money for a toothbrush, it better clean my teeth with gold bristles. This toothbrush unfortunately didn’t, but it did leave a sour taste in my mouth.

I got hit with an overdraft fee, that painful penalty your bank charges when your account doesn’t have enough money to cover a debit card purchase. It was my fault – I should’ve kept a closer eye on my account–but stuff happens. Last year, banks made $38 billion in overdraft fees. Clearly, I’m not alone.

Photo: BBB

It’s been common practice for banks to automatically enroll their customers in overdraft coverage plans. Under these plans, banks “cover” for customers who swipe their card for amounts that exceed their available funds. Banks pay the difference to the merchant and charge consumers for the service, usually around $30-$35 per transaction. It hasn’t been uncommon for consumers to get hit with multiple fees in a day if they were unaware that their balance was running low, and that can really add up ($38 billion!). Overdrafts have been a major source of revenue for banks and an even larger source of gripe for consumers.

But change is coming. In March, the Federal Reserve imposed new rules that will fundamentally change the overdraft game, as of next week.

What’s new?

Beginning on August 15th, banks will no longer be able to charge overdraft fees unless customers explicitly opt in to the overdraft coverage services. Banks have been required to send a notice to all consumers detailing how they will treat overdrafts moving forward–a welcome departure from years of hiding fees in the fine print. Unless you reply to your bank’s notice giving specific permission to overdraw on your account, you will no longer be able to withdraw money or make purchases that will bring your account balance below $0.

Here are the details for new and existing accounts, straight from the Federal Reserve:

  • Existing accounts. If you do not opt in (agree), beginning August 15, 2010, your bank’s standard overdraft practices won’t apply to your everyday debit card and ATM transactions. These transactions typically will be declined when you don’t have enough money in your account, but you will not be charged overdraft fees.
  • New accounts. If you open a new account on or after July 1, 2010, your bank cannot charge you overdraft fees for everyday debit card and ATM transactions unless you opt in. If you opened a new account before July 1, 2010, your bank will treat you as an existing account holder: you will receive a notice about your bank’s standard overdraft practices and will have to decide if you want them for everyday debit card and ATM transactions.

Note that checks and automatic bill payments are not covered under the new overdraft regulation, so make sure to keep a close eye on your checks and recurring bills (cell phone bill, utilities, etc).

As the New York Times explains, consumers are effectively charged an annual interest rate of 3,520 percent if they overdraw on a purchase of $20 and get hit with an overdraft fee. Which begs the question, why would anyone opt in to overdraft coverage?

Many banks argue that overdraft coverage makes sense, claiming that it allows consumers to make essential purchases, avoid missing payments and escape the public embarrassment of getting declined at the register.

Personally, I’m saying “No, thank you.” I’m fortunate enough to have a credit card if I’m ever in a bind. But I’m curious why anyone would opt in. If you’re planning on doing so, let me know why in the comments. Alternatively, feel free to use this space to vent about your own “golden toothbrush” story.