Are overdraft fees predatory?

We often think of overdraft fees as, well, a fee that you have to pay if you accidentally overdraw your account. This could happen for a variety of reasons from mistiming when your rent is pulled from your account to not getting paid on time. Instead, however, it can make sense to think of an overdraft fee as a very expensive loan with an extremely high interest rate. Regardless of how we classify them, overdraft fees can turn predatory when you’re charged over and over without your knowledge or if you’re docked a lot of money for a single offence.

Overdrafting is something to be avoided at all costs but especially if it falls into the predatory category. We’ll cover a few things to look out for and how to protect yourself and your financial future.

What are overdraft fees?

Banks and credit unions often offer overdraft fees couched in the language of customer service. Imagine if you head to the grocery store and pick out your food. You wait in that long line to check out, behind the lady who has, for some reason, purchased all of the cans of beans the store has. You make it up to the register and go to pay. The cashier looks at you and quietly says, “I’m sorry but your card has been…declined.” The embarrassment! You can save yourself from that embarrassment by signing up for overdraft protection. With this service activated, your bank will cover the difference of the transaction and charge you a fee for doing so. It can also charge a fee for each additional day your account is overdrawn.

This seems like a relatively nice service right? When used with full consent and understanding, yes. But that’s not always the case.

The problem with overdraft fees

Overdraft coverage seems great on paper. They help you complete purchases and avoid being declined at the cash register. Unfortunately, they’re also a great profit centre for financial institutions, which creates an incentive for banks to keep them high and used frequently. In 2020 alone, banks collected $46 billion in overdraft fees from consumers and businesses. The average overdraft fee in Canada is $35 per transaction.

In the United States, whose banks charge similar fees, nine per cent of account holders paid 84 percent of the overdraft fees. Those customers tended to carry low balances, averaging less than $350. The study referenced, performed by the Center for Responsible Lending, a US-based consumer advocacy organization, finds that people who make use of overdraft fees are exactly the type of people who can’t afford to lose out on any additional money.

These types of fees start to get predatory when we consider how consumers sign up for them. Frequently, banks and credit unions will enroll consumers in “overdraft protection” services automatically. The terms and conditions of the service will be buried in other small print when opening an account. Consumers can opt out of the services, but it’s not always apparent how this is done. Moreover, consumer advocates argue that consumers aren’t informed quickly enough when an overdraft actually occurs. In this way, banks and credit unions can charge overdraft fees for each subsequent charge without the consumer being aware that they’ve pulled more cash out of their account than they have.

In essence, you can think about overdraft fees like a loan. Let’s say you make a purchase of $101 but only have $100 in your bank account. Your bank will activate your overdraft protection and would charge a $35 fee for the service.

Are these actually legal?

Yes, Canadian financial institutions are permitted to charge overdraft fees. There are laws that govern how banks and other financial institutions charge overdraft fees. Financial institutions will often charge overdraft fees in one of three ways:

• Pay-per-use: This is exactly how it sounds. Each time you overdraft, the bank will cover the difference and charge you a fee for the service. Generally, the bank will continue to do this multiple times up to a limit of, say, $200.

• Pay-per-month: Banks will often also charge a monthly fee for enrolling in the overdraft protection program. They can charge this fee in combination with the pay-per-use fee or have a timeframe in which you must make your account whole or face additional fees.

• Interest: Sometimes, the bank will allow you to overdraft and charge you a set interest rate for the service. This is often calculated daily until you return your account to a positive.

While legal and convenient, overdraft fees can become very expensive, very quickly. If you’re already living paycheque to paycheque or you don’t have a budget, overdraft fees can make financial success difficult.

How to protect yourself

Here are a few tips to protect yourself from predatory overdraft fees:

Proper budgeting

The key to avoiding overdraft fees, and most other aspects of financial success, is proper budgeting. Having a complete understanding of the amount of money you have coming in each week or month, how much you need to pay for bills, groceries, and other expenses, and importantly, when those things happen, is critical. There are lots of budget templates and websites out there and KOHO offers quite a few helpful ones:

• Budgeting for a better world

• How to budget as a millennial

• The ultimate budget template

Linking your account

Many financial institutions will allow you to link your chequing account to either a credit card or another account, such as your savings. They may still charge a fee for the use of the service, but it is often far less than the overdraft fee itself. Check your bank’s options and settings to determine if account linking is an option.

Use credit

Using a credit card has many different benefits, from ensuring that you don’t overdraft to taking advantage of some of the rewards programs that are offered by financial institutions. If you do a lot of traveling, a card that earns frequent flier miles may be worth it. Big fan of Starbucks? There’s a credit card for that too. The important thing to remember about credit cards, however, is that you have to repay them! Ensure you only spend what you’ve budgeted for in a given period. If you’re not able to stick to this budget, using credit may not work for you. Just make sure to pay your balance back in full each month. If you aren’t in the habit of paying your credit cards off each month, you should consider other alternatives.

Use prepaid cards

Prepaid cards combine the ease and flexibility of using plastic to pay for things with the protection of not overdrafting. You can easily reload these cards at many grocery stores, pharmacies, or convenience stores and you’ll only be able to spend exactly what you’ve supplied. There is usually a fee for using prepaid cards, but it is relatively minor when compared to overdraft fees. KOHO has a variety of prepaid cards available as well. These cards offer rewards like 2% back on certain purchases, low or no monthly fees, and included financial coaching. Best of all, there are no overdraft fees, ever.

Use cash only

This may be a bit of a drastic step given our society, but if you have trouble budgeting and are not able to effectively handle a credit card, visiting an ATM and using cash only may be your best bet. It is impossible to spend more than you have when using this method of payment.

Overdraft Has Its Place

Overdraft fees can be a positive for many people. If you make an error in math or simply mistime when you’re paid, overdraft fees can allow you to continue shopping without the fear of being declined at the register. However, overdraft fees need to be included as an emergency stopgap in your financial strategy, not a tool you use frequently. Budgeting and the use of other products like credit cards or even cash are preferable to paying overdraft fees on a constant basis.