Do You Understand Your Debit Card?

Debit cards are commonly seen as a good thing – a way to spend only money I have [unlike a credit card where you can obviously spend money you don’t have]; in theory, this is a good thing, but is this reality? It used to be - not any more. Did you know that if you don’t have enough money in your account to cover a debit card purchase (including ATM transactions) you probably won’t be denied? What? Isn’t that the reason most people use debit cards – to avoid that problem? A recent study has discovered that most banks will actually allow the transaction to go through …

Today, many financial institutions enroll customers [by default] in overdraft (“bounce protection”) programs when they open checking accounts. Under the program, the fee a customer pays when a withdrawal exceeds the available account balance is actually a finance charge for a loan. These overdraft loans are usually very short term and very costly. When these fees are converted to APR (the common measure to express the "true cost" of credit), the APR is often quadruple digits (or higher)! A 2005 report published by the Center for Responsible Lending (CRL) found that checking account holders will pay more than $10.3 billion in overdraft loan fees each year. The number one cause of overdrafts? Debit card purchases! These debit card overdraft loans have proportionately much higher APRs because they carry the same flat-rate fee on what is typically a much smaller transaction amount.

To me, the irony of this all is that banks have the technology capable of warning customers at the time of a debit transaction or ATM withdrawal that their account has insufficient funds, yet most do nothing about it. They can also decline the transaction and save the customer the overdraft fee, yet most do nothing about it. Yet, the CRL study learned that most people would prefer that the bank deny their withdrawal or purchase when they don’t have adequate funds in their account to pay for it.

Summary of CRL Findings.
- 46% of all overdrafts were triggered by debit card transactions.
- 72% of overdrafts were for electronic transactions (debit, ATM, etc.)
- Debit card overdrafts cost [median] $2.17 for every dollar borrowed
- Check overdrafts cost [median] $.86 per dollar borrowed.
- Expressed as an APR, the median debit overdraft rate is 20,000%+.
- 61% would prefer a denied purchase than an overdrafted account.
- 98% would cancel an ATM withdrawal if warned of insufficient funds.

Given what we know (in the past decade, debit card use for purchases has grown at an explosive 20% per year), it is likely the problem will continue. It is anticipated that a fee-based overdraft loan program will boost a bank’s overdraft revenue by 200% to 400%. I bring this to your attention primarily to enable you to be aware of the potential, costly trap of debit card overdrafts. In the study, over 60% of respondents who overdraft thought that they had enough money in their account to cover their purchase or ATM withdrawal.

Bottom Line.
Monitoring your account(s) regularly and maintaining a check register are a couple of simple things you can do to help avoid the problem created by overdrafts.

- CRL Report
- Montana State University Extension Check Register
- OFS Budgeting and Money Management Resources