Is Overdrafting Your Checking Account Worse Than Getting a Payday Loan?

Overdrafting Your Checking Account is Worse Than Getting a Payday Loan

Hypothetical question: Your bills are due and your car needs gas, but your bank account is empty. You need to borrow $100 for 2 weeks.

Your options are:

  • Overdraft your checking account, once, at a Bank of America ATM
  • Run up credit card debt for a month at the maximum legally permissible APR
  • Get a payday loan from Cash America

So what should you do?  The choice is not even close, and you can use a calculator if you ever face a similar decision:

Loan Overdraft at Bank of America ATM $100 in Credit Card Debt at 29.99% Payday Loan from Cash America, California
$100 Fees: $35APR: 912.49% Interest: $2.50APR: 29.99% Fees: $17.64APR: 459.90%

 Overdraft Fees Are Evil.

The really shocking thing about overdraft fees is that up until August 15, 2010, your bank could opt you in for “overdraft protection” without your consent. This becomes a huge issue when you don’t realize that your account is empty, and get charged $35 each time you use your debit card until you realize something is wrong.

The Fed realized that most people didn’t want this “protection”, and mandated that banks must get your consent before they “protect” you. As a result, banks are now spamming the living daylights out of customers to encourage people to “opt-in”. I’ve ignored at least 15 letters from Chase over the past few months alone.

Even still, banks like TCF Financial in the Midwest keep claiming that most people actually want this service. Whether through lack of education, deceptive marketing, or browbeating, they’ve managed to get over half of their existing customers to opt-in, and over 80% of their new customers. Many other banks are also at over 50% opt in rates.

Why Are 80% of New TCF Financial Customers Signing Up for Overdraft Protection, While Bank of America Ends the Practice?

TCF ‘s 80% opt in rate for new customers is a real head scratcher. I chalk it up to deceptive marketing practices, and the fact that the bank targets students who don’t know any better, given their huge presence on campuses. TCF’s explanation? Something along the lines of, “nobody wants to look like a fool at the cash register”. Note that this is a bit of a hot button topic for them since overdraft fees account for their entire profit stream.

Meanwhile, Bank of America announced earlier this year that they have ended overdraft protection at the POS, because it’s pissed off so many customers. During their most recent earnings call, they stated that 10% of customers were paying 70% of the overdraft fees, and that 10 million customers jumped ship last year, largely because they were pissed about overdraft charges. You can see some interesting stats on slide 9 of their earnings presentation.

Are Debit Cards Actually the Evil Ones?

I can’t believe I’m writing this, but the moral of the story is – if you need money, you actually come out ahead by running up your credit card rather than overdrawing your checking account. As far as finding a credit card to run up, make sure you find a low APR credit card or balance transfer credit card, rather than a cashback credit card, given the fact that cashback credit cards tend to have much higher APRs.

Regardless of how you finance the loan, also be careful not to fall into the cycle of coming up $100 short each month. The reason there are so many payday loan centers is because this happens to so many people, and it’s very good business.

About the author

Tim Chen is CEO of NerdWallet. NerdWallet helps you find the best credit card, by sorting nearly 600 credit cards by best rewards and lowest APRs.  Tim writes about credit cards for the Forbes Moneybuilder Blog, Huffington Post, and the Christian Science Monitor.  He is also a fellow member of the Yakezie Network.

7 Responses to Is Overdrafting Your Checking Account Worse Than Getting a Payday Loan?

  1. Ron says:

    Don’t forget the fees charged by the merchant. That 912% could easily double!

    This article could be a stunning revelation to some.

  2. Pat says:

    Ouch. I cringed the whole time while reading this article. This is probably one of the best examples of when a credit card is better worth using than any other loan. At least a credit card can act like a 30-day loan.

  3. That is really an interesting comparison, and surprising.

    I have a line of credit at the credit union that will cover an overdraft — when my beloved (former) employer jumped into PeopleSoft without adequately planning and without a back-up system, some people didn’t get their paychecks, so I asked for a credit reserve in the amount of one month’s pay. Mercifully, I’ve never had to use it. But thanks to this intelligence, if I’m ever in that position, I sure will think twice!

  4. Aloysa says:

    Actually you also can apply for a line of credit that is tied into your checking, so that when you overdraft, money comes out of your LOC and you don’t get hit with huge overdraft fees. Unfortunately not every bank offers LOC. Credit unions do.

  5. Credit Card Hub says:

    This is a great point – I would even make the credit card URL be 60% – I think this is the highest I have even seen (from a First Premier Offer) in order to drive the point home.

    It is easy for people to criticize credit cards, but the truth is that for some people they represent a lower cost of borrowing than the alternatives!

  6. I’ve always wondered about this when people were crucifying payday loans. Of course, they’re not good, but they are really no different from overdraft fees, ATM fees on small withdrawals, or even rapid refund fees!

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