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Overdraft charges and NSF (non-sufficient funds) charges are a profit center for banks, and a quicksand-like pitfall for many consumers. In total, consumers pay more than $10 billion in overdraft and NSF charges each year, though that number was slightly lower during 2020 due to pandemic-related policies.
Some of the largest banks rake in well over $1 billion annually in these charges.
For some, these fees make up a substantial portion of annual income. The charges can be so destabilizing to a consumer’s finances that early in the pandemic, federal officials called on banks to stop charging overdraft fees during the crisis. Results were mixed.
What’s the Difference Between an Overdraft Charge and an NSF Charge?
Most people don’t give much thought to the distinction, since at many banks overdraft fees and NSF fees are the same amount. But, they can play out very differently. Understanding how each works and what aspects of the process you can control may save you money.
An overdraft occurs when the bank processes a payment even though you don’t have sufficient funds. Imagine, for example, that you have $500 in your checking account and a debit card transaction for $525 is attempted. If the bank authorizes the charge, your account balance is -$25. Then, the bank will typically apply an overdraft charge–$35 is common. Once that fee is applied, your balance is -$60.
Overdraft charges can pile up quickly, for two reasons. One is that each item triggers a separate fee. Imagine that in the scenario described above, two checks hit your account the next day and are paid. These are small checks, just $10 each. Now, your account balance is -$80. Then, the two additional overdraft fees are applied, and you’re at -$150.
It’s not hard to see how easily this can spiral out of control. While banks limit the number of separate overdraft fees you can be charged in a day, those charges still add up. Four ($140/day at $35/overdraft) is common, but some caps are much higher.
If you don’t have the funds to cover the overdraft right away and your bank is one of the many that charges an additional fee if your account stays overdrawn for too long, you may start incurring additional fees even if there haven’t been any further transactions. This may be a small fee of about $7 or $8 that is applied daily after a certain point, or a larger fee in the $25-35 range that is applied once every five days that the overdraft continues.
How Can You Protect Against Overdraft Fees?
Fortunately, it’s not entirely up to the bank whether to pay debit transactions when you have insufficient funds or funds deposited to your account are not yet available. Since 2010, federal regulations have prohibited banks from charging overdraft fees for ATM or debit card transactions unless the account holder affirmatively opts in.
If you haven’t given that consent, the bank may or may not still authorize the charge, and that may mean a negative account balance. But, the bank can’t charge you a fee for processing that transaction when you have insufficient funds.
Be aware of this when opening a new bank account, and carefully assess which option is best for you. If you don’t opt in, debit card transactions will typically be declined if they would overdraw your account. That can be inconvenient or briefly embarrassing, but it can prevent a chain of payments and charges that can leave a deep hole in your bank account. And, you won’t be charged a fee. If you don’t know whether you opted in or not, you can check with your bank. You can always make a change.
An expert tip from Erik
Depending on your bank and your financial situation, you may have other options for avoiding overdraft charges. For instance, you may be able to link a savings account to your bank account so the bank can automatically transfer funds to cover any checks or debit transactions if you have insufficient funds in your checking account.
There may be a transfer or transaction fee associated with these types of overdraft protection. But, it is typically much lower than an overdraft charge, and it prevents one overdraft from triggering a chain of additional fees.
An NSF fee is a fee charged by the bank when an item is returned unpaid. If you have a $300 balance in your checking account and a $325 check is presented, what happens next depends on a variety of factors, including what arrangements you’ve made for overdrafts.
One possibility is that the bank sends the check back marked “NSF.” Since they haven’t honored the check, your account doesn’t go into the red. But, you’ll likely be charged an NSF fee. The NSF fee is often the same amount as an overdraft fee. The difference is in how that plays out.
Since the bank is deducting only an NSF fee from your account (let’s say $35), your balance doesn’t go negative. In this example, you’ll be at $265. That means when those two $10 checks come through the next day, they’ll be paid out of your remaining balance and no fees will apply.
There are downsides, too. Since the check was returned unpaid, you may be responsible for late fees or a returned check fee to the recipient (or both). And, when a check is returned, it can be presented again. That means you may incur more than one NSF fee for the same item.
NSF fees differ from overdraft fees in one other important way. Unless the consumer has opted out, an overdraft fee may apply to any type of transaction. But, NSF fees typically aren’t applied to electronic transactions that are declined. So, a bounced check might mean a $35 overdraft fee, while a declined debit card transaction in the same amount would cost nothing.
Recap: Overdraft Fees vs NSF Fees
An overdraft occurs when the bank processes a payment even though you don’t have sufficient funds.
An NSF fee is a fee charged by the bank when an item is returned unpaid.
Requesting Removal of Overdraft and NSF Fees
You may be able to get some overdraft or NSF fees reversed with a simple phone call to your bank. This is most often effective when you typically manage your account responsibly and something goes wrong, like an automatic deposit taking longer than usual to credit.
If you’ve hit one of those cascades described above and piled up overdraft/NSF charges that put you deep into negative numbers, the bank may agree to remove some fees to help you get the account back on track.
There’s no guarantee, but there’s also no harm in reaching out to the bank and asking to have some or all of those fees removed.
Overdraft Charges are Dischargeable in Bankruptcy
When overdraft/NSF fees pile up, the impact can be serious. Direct deposits can disappear into a black hole created by fees, making it impossible to catch up. This leads some consumers to abandon accounts. In other cases, the bank closes the account due to a continuing overdraft. Either way, that unpaid balance is a debt that may go to collections like any other. But, if the amount is unmanageable–especially if it’s combined with other overwhelming debt–Chapter 7 bankruptcy may offer a way out.
Overdraft Changes on the Horizon
The overdraft problem has been on the radar of consumer advocates and government agencies for some time. More than a decade ago, several banks–including Bank of America–settled lawsuits regarding their application of overdraft fees. A key issue in many cases was the practice of transaction reordering.
In simple terms, some banks process transactions out of order, to deduct the largest items first. This practice can dramatically increase overdraft fees.
Imagine, for example, that you have $100 in your checking account and five transactions are presented in a single day, in the following order:
If those transactions are processed in the order they were presented, the first four transactions would be paid from available funds. The fourth would either be paid or returned, either option likely resulting in an overdraft or NSF charge of about $35.
With the largest first system, the $105 item would be processed first. If that item was paid, the account would go negative before the four earlier transactions were processed. That means five overdraft/NSF charges instead of one. Despite the litigation and settlements, some banks still employ this method.
In 2013, the CFPB reported that annually, more than 27% of consumer bank account holders had at least one overdraft charge. The average total annual overdraft fee was $225. And, about 6% of consumer bank accounts were involuntarily closed in a single year, with negative balances being by far the most common reason. The agency determined that further investigation was required. But, little changed.
The financial challenges many Americans faced during the pandemic turned the spotlight back on overdraft fees, and some changes are underway.
New California Law Limits Non-Bank Overdraft Fees
A CFPB rule places significant restrictions on overdraft fees applied to prepaid cards. But, non-banks have found ways around those limits. In October, California Governor Gavin Newsom signed legislation that will close that loophole for many California consumers. SB 497 changes the definition of a “qualified account” for deposit of a wide range of state payments and benefits.
Under the revised law, these payments may be deposited to a prepaid account, demand deposit account or savings account with an entity other than an insured depository financial institution only if the account:
- Is not attached to an automatic credit or overdraft feature, or
- The credit or overdraft feature has no fee associated with it, or
- It complies with the requirements for consumer credit under the federal Truth in Lending Act
Though this new provision won’t apply to all California consumers, the statute extends protection to those who may be particularly vulnerable, such as recipients of unemployment compensation and disability benefits. The new law also applies to child support payments collected by the state and passed along to parents.
Pending Federal Overdraft Legislation
Last year, U.S. Senators Cory Booker and Elizabeth Warren introduced the Stop Overdraft Profiteering Act of 2021. There’s been no action on the bill since it was referred to the Senate Committee on Banking, Housing, and Urban Affairs on August 9, 2021, and the legislation has received little attention.
If passed, the federal statute would require opt-in (in writing) for overdraft coverage, limit the number of overdraft coverage fees that could be charged in a calendar month and in a calendar year, and limit the amount of overdraft charges to an amount “reasonable and proportional” to the institution’s costs in handling the overdraft.
Voluntary Termination of Overdraft Fees
The growing attention to the problems associated with overdraft and NSF fees has had an unofficial, but promising, impact: many banks have announced that they are voluntarily ending overdraft charges.
In December, Capital One announced that it would no longer charge overdraft or NSF fees on its consumer accounts. Capital One is the largest bank to have made this move so far. When the new rules roll out in early 2022, customers will still be able to opt-in to overdraft protection, and overdraft protection will continue for customers already enrolled–there just won’t be a fee. For customers who don’t choose overdraft protection, transactions that exceed available funds will be declined or returned–also without a fee.
Though other large banks haven’t yet taken that leap, several are rethinking the way they handle overdrafts and looking to reduce dependence on overdraft and NSF revenue.
Managing Overdraft Charges
With so many changes underway, the first step toward avoiding unmanageable overdraft and NSF charges is to understand your bank’s policies. Make sure you’ve made a conscious decision about whether or not to allow your bank to pay charges that would overdraw your account, and that you know exactly when you’ll be charged and how much it will cost you.
You may want to consider shopping for a bank that has eliminated overdraft and NSF fees. But, be sure to compare all fees and costs rather than focusing on just this one issue.
If you’re already in trouble with overdraft charges that have spiraled out of control and are struggling with other debt, consider consulting a California debt relief attorney about your options.