First Person: How I Beat Bank Overdraft Fees

Overdraft fees can be really frustrating. For every dollar you cannot afford to pay for your transactions, banks are charging you $35, which means that you can easily be charged $35 for a $2 cup of coffee if your checking account balance is not enough. Moreover, overdraft fees can head up really quickly.

Here is how overdraft fees work: let's assume that you don't have enough money in your checking account and you need to cover for several small charges that are $2, $3 and $4. The total amount you need to cover is $9. For this $9 your bank is charging you three overdraft fees of $35 each, which totals up to $105 in fees to cover $9.

You are required to put back the overdrawn money, plus the fee, within 30 days. If you don't, interest charges apply. In any case, overdraft fees can be really costly and if you don't follow several steps to beat overdraft charges, you can really quickly get into huge debt.

You Can Opt-Out of Overdraft Fees

Since August 15, 2010, the Federal Reserve has initiated a rule that does not allow banks to automatically enroll their customers in overdraft protection service. Banks are required to ask their customers if they accept bank overdraft fees. This means that, unless you sign up for overdraft protection, your bank is not allowed to charge you an overdraft fee on ATM or debit transactions. They are only allowed to deny your purchase if your account has insufficient funds.

Following the Federal Reserve rule, U.S. Bancorp, Bank of America and ING Direct have lowered or eliminated overdraft fees, while Chase Bank has been promoting the advantages of overdraft fees. Citibank has argued the rule suggesting that customers should get an alert when their account balance is low in order to choose another form of payment and cover for their debit or ATM transactions. Wells Fargo was ordered to return $203 million to its customers being accused of profiteering by overdraft policies. Different reactions from different financial institutions, but the bottom line is the same: banks are charging an overdraft fee to make you get a loan to cover a transaction. And when they don't charge you an overdraft fee, they make their overdraft protection offer, which again is profitable only to them.

Create Your Own Overdraft Protection

No matter what your bank's overdraft protection offer is, it is to your best interest to create your own overdraft protection. What I did was to set up an email alert on my online bank account to get a notification service based on my account balance threshold. I have set up $500 as a limit. If my account balance goes below $500, overdraft protection automatically transfers the amount of money that exceeds my account balance to cover for any overdraft checks or debit transactions. In that way, I avoid any problems with overdraft charges.

How to Beat Overdraft Fees

There are several ways to beat overdraft fees, besides opting-out. Keep in mind that even if you opt out overdraft protection, banks can still charge you on overdrawn checks or automatic payment programs used for your rent or mortgage payments or utilities. Unfortunately, the Fed rule does not cover for these areas and even if you sign up for overdraft protection services with your bank, like I did, you will still be charged with overdraft fees.

This is my approach to beating overdraft fees:

-- Balance your checkbook

By balancing your checkbook, you stay in close contact with your account balance and are able to know exactly how much money you have in your account at any given time. You should be aware of your balance at all times to avoid making debit purchases that you cannot afford or writing checks that could lead to overdraft fees.

However, make sure that your account balance is the "available" balance. Sometimes, if you have made a credit purchase and it hasn't cleared out yet, your account balance is not the actual one. Banks hold your money for 3 business days until they receive a receipt of payment for your credit purchase. If they don't, they release the money back into your account. However, typically credit transactions take much longer to clear out and therefore, available balance is actually "expected" available balance.

-- Link your checking account to your savings account

Nearly any bank allows you to link your checking account to your savings account. This can be done very easily and quickly and I can tell from personal experience that it is an excellent method of money management. By linking your checking account to your saving account you are less likely to overspend your money. In case of an overdraft check or a debit transaction, the savings account will automatically transfer money to your checking account to avoid overdraft fees. Just make sure you have your savings account in good standing at all times.

-- Use cash

Most people don't like using cash for their transactions. They find it inconvenient compared to the ease of using credit or debit cards or they feel they cannot keep track of their spending.

As a matter of fact, by using cash for your transactions:

You can control your finances: You know at any given time how much money you spend for your transactions and how much money you have left in your wallet.

You don't incur any fees: There are no late or hidden fees or over-the-limit charges. There are no billing mistakes or overcharges on your bank account. Ultimately, there is no risk of damaging or ruining your credit record, but most importantly, you don't bear the risk of going into debt.

You can get discounts: Cash is accepted everywhere. Moreover, you are very likely to get discounts for paying in cash, thus saving even more money.

In contrast, as the most recent credit crisis has proved credit card debt builds up exponentially and interest rates can head up really quickly. Moreover, by charging smalls amounts of money to your credit card you add to your credit card bill and you lose track of your spending.

-- Keep a budget to manage your spending habits

Another method that has really helped me a lot to avoid overdraft fees is keeping a budget for managing my spending habits. Especially, the envelope system allows me to manage my cash really effectively and, to my view, is one of the most efficient money management systems.

Here is what you need to do:

First, you should decide on the cash categories based on your spending habits including groceries, gas, utilities, insurance, children, and so on. In that way, you are able to better monitor and control them. Then, you create an envelope for each category and allocate the proper amount of cash on a weekly basis. Once, the cash is out, you are not allowed to use your debit card or credit card, write a check or go to the ATM because once you do that you know that you will be charged with overdraft fees.

-- Use a cushion on your checking account

This is a suggestion that possibly does not apply to everyone. However, if you can afford to save a baseline of $100, or $200 in your checking account as a cushion to cover for unforeseen expenses, you can automatically avoid overdraft charges.

Conclusion

A $35 fee per $1 overdraft equals to 340 percent profit on $1 loan. Some people believe that banks are not responsible for overdrawn accounts. They are charging $35 fee because they are offering a service by letting you draw money from your account. But, it has gotten to a point where you get overdraft charges for a few dollars. The bank is transferring $100 to your account and charge you with $35 fee, and this can occur several times a day per customer, guaranteeing a few hundred dollars profit in a day for the bank. This explains why banks generated an estimated $38.5 billion from overdraft fees in 2009.

You need to understand that regardless any regulation or Fed rule, the system is built to keep consumers who are in debt, in debt. Half of the U.S. banks would not even be profitable without overdraft fees. No matter what overdraft policies they promote and if they lower or eliminate their overdraft fees, banks use other methods to charge you hidden fees including reordering transactions and delaying deposits. What you can do is be alert and control your spending.

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Control Spending by Using Cash