Cash advance loans are expensive, but so are overdraft loans

We have written extensively about the problem of payday loans and how the industry charges interest rates of 500-1000% from customers who often cannot afford to borrow money elsewhere. The industry is well regulated in some states and ignored in others, but one thing remains constant - customers take out those high interest loans because they want to. No one forces them to do it and the lenders are required by law to fully disclose the terms of the loan ahead of time. In short, the borrowers, for better or worse, know what they are buying.

That’s not necessarily the case with overdraft loans or overdraft “protection” as it is often called. Many banks now include such protection as a built-in feature of their checking accounts. If a customer writes a check or makes a debit card purchase for more money than he or she has in their account, the bank will honor the transaction. The customer will then be charged a fee for the overdraft. The fees vary from bank to bank, but typically range from $20-35 per transaction. A $35 fee, repaid in two weeks’ time, amounts to 910% interest annually. If the customer repays within a week, the effective annual interest rate is an astonishing 1820%.

The ability to draw more money than you might have in your account is useful, we suppose, particularly in light of the fact that few people ever balance their checkbook properly. That being the case, few people know how much money they are supposed to have in their account, making overdrafts all the more likely. The problem is that banks automatically include this protection feature and don’t allow customers to “opt out” of it. Furthermore, the customer gets no warning if he or she is about to overdraw their account. It just happens, and the fee is automatically assigned.

This is profitable business for the banking industry, which takes in more than ten billion dollars a year in overdraft fees alone. This is profitable lending, but unlike payday loans, customers don’t always realize that they are even borrowing money. If they did, they might be less likely to do so, especially if they knew that overdrawing an account by $5 still requires a $35 fee. Would anyone take out a $100 payday loan if the fee were $700? Probably not.

In an ideal world, banks would be required to notify customers that such protections are in place. They would also be required to allow customers not to participate if they elected to do so. Given the current climate in Washington and Congress’ rather favorable view of the banking and lending industries, it seems unlikely that any legislation along these lines will come along any time soon. In the meantime, we recommend that customers balance their checkbooks a bit more often.

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