Critics of payday loans frequently site that the annual percentage rate (APR) for such short-term micro loans is rather high, typically reaching figures in the neighborhood of 391 percent.
Even though APR is not entirely compatible with payday loans (which are often two-week loans, making full-year interest rates immaterial), lets assume for the sake of argument that 391 percent is accurate.
Next, let’s assume that consumers facing a small financial crisis will rely upon a product like checking overdraft protection once in a great while if their balance is low and an unavoidable expense threatens to overdraw their account. Overdraft protection of this nature is quite common and readily available, in much the same way that no fax payday loans are available for short-term cash problems.
Is Overdraft Protection a More Cost Effective Option Than Payday Loans?
A November 2008 study by the Federal Deposit Insurance Corporation (FDIC) answers that question with a resounding NO. In fact, their study of 1,171 FDIC-supervised banks presents hard data that proves that their overdraft programs are prevalent, often deceptive, generate tremendous revenue and exploitative. Here are some highlights:
Overdraft is prevalent…
- 86 percent offer at least one type of overdraft program
…deceptive…
- 75 percent automatically enroll customers without asking; customers must voluntarily opt out. In some cases, the option to opt out isn’t even available
- 81 percent permitted overdrafts at ATMs and points of sale (POS), and most informed customers of the overdraft only after it occurred (88.8 percent for POS and debit transactions, 70.7 percent for ATMs)
…generates tremendous revenue…
- Median overdraft fee is $27; a $27 fee for a single $60 instance, repaid in two weeks, translates into a 1,173 percent APR
- Banks earned $1.97 billion in NSF fees in 2006, which was 74 percent of all service charges and six percent of net operating revenue
- Banks with overdraft programs had higher NSF-related fee income than other banks
- Customers with 5 or more NSF transactions over the 12-month period of the survey accounted for 93.4 percent of total NSF fees reported
- Customers with up to four NSF charges paid $64 per year on average; those with 20 or more paid $1,610
…and exploits customers
- Approximately one quarter of the banks with automated overdraft protection also assessed additional fees on top of the NSFs for retaining a negative balance
- Accounts held by customers in low-income areas (media household income below $30,000) were more likely to incur overdraft charges than those in higher income areas; more than 38 percent of low-income accounts had at least one NSF fee, compared with 22 percent of upper-income accounts
- Assuming the median $27 overdraft fee, a customer paying a $20 POS/debit overdraft in two weeks would pay an APR of 3,520 percent; a $60 ATM overdraft would be 1,173 percent; a $66 checking overdraft would be 1,067 percent
- If overdraft fees are repaid more quickly, the resulting APR is actually higher
- Accounts held by customers 18 to 25 are much more likely to incur NSF activity (46.4 percent)
Before a consumer relies upon overdraft protection to cover themselves in the event of a short-term financial emergency that can drain their account, they should consider the facts. The expense of this service alone is prohibitive, and banks don’t make it easy to get rid of (or even get rid of in some cases). Payday loans are a safer, less expensive, more convenient option for consumers who wish to escape excessive debt rather than create it.
Banks make way too much money off overdraft fees, and I didn’t know that some banks automatically enroll you, I’m going to my bank tomorrow to make sure I’m not enrolled in one.
This is really not surprising. It is a bit shocking to think of banks, who we would normally want to trust, as wanting us, as their customers, to incur fees so they can reap the benefits, but I suppose its the way the world works. I kind of wonder why they haven’t been charged fees for the lending practices that resulted in the current recession.
This is really helpful I never thought of how the interest rate really do work on NSF fees from the bank. Very helpful in deciding if a payday loan was right for me or if NSF fees were better to get.
Very good research. Thank you!
*****
I was in Sedona, AZ, recently [pre-election] & heard many radio ads regarding Payday Loan legislation that was on the ballot. Nothing was mentioned about the banks who are undoubtedly carrying on such practices as described in this info.
I do have an automatic line of credit on my checking account, and when I goofed up one time, it was not too pricey!