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Many Reasons Not to Use Your Checking Account as a Short-Term Loan

Woman in debt

The Consumer Financial Protection Bureau says banks make $30 billion from customers who overdraft their checking accounts regularly – and 8% of customers are responsible for 75% of the fees.

If you’re one of the 8 percent, you need to realize you have much better options. In fact, studies have shown that even the much-maligned payday loan costs less than over-drafting your account.

Why People Overdraft

While it’s true that some consumers simply don’t track their checking account balances regularly, others knowingly lean on the overdraft protection to tide them over when they face a financial emergency. surveyed 1,000 people to find out who does this and why. Here’s what they found.

  • 14% didn’t keep up with their balance
  • 6% indicated the purchase was a necessity
  • 4% were confused by the banks overdraft policy
  • 3% didn’t mind the fees
  • 70% said they never over-drafted their accounts

So who didn’t track their account balances on a regular basis?

Age played a big part in the equation. Those aged 18 to 24 were overrepresented in the group that didn’t keep up with balances, had the most overdrafts, and didn’t really understand the overdraft policy.

Why Overdraft Protection Is Your Worst Option

The FDIC, which regulates banks, also did a study and arrived at some troubling findings. (
First and foremost, most bank customers aren’t even given information about the overdraft policies until after an ATM or point-of-sale overdraft occurs. Plus, the bank fees — or cost of the transaction — can exceed the cost of payday loans.

The FDIC found that overdraft fees range from $10 to $38, but on average the fee runs about $27.

So let’s look at a common transaction resulting in an overdraft fee. A customer goes to the ATM and withdraws $20 and gets hit with a $27 fee for over-drafting his account. That comes out to an annual percentage rate of over 3,500 percent if paid back in two weeks. This surpasses rates charged for the much-criticized payday loan.

(Note: You figure the annual percentage rate by taking the amount paid in fees $27, which is 135 percent of $20 and multiplying it by 26. There are 26 two-week periods in a year.)

How These Loans Really Compare

Payday loans amounts usually range from $100 to $1,000 based on your state’s laws. Some payday loans do have longer terms, but we’ll use that repayment period for our comparison.

Payday loans typically cost $15 to $30 per $100 borrowed. If you pay back the loan on time, the annual percentage rate would come out to 400 percent (If you pay $15 for $100, your interest is 15%, which multiplied by 26 gives you and APR of 390%.) Even at this high rate, the overdraft fee is 900 percent higher.

Why You Should Try Other Loan Options and Not Overdraft Fees for an Emergency Cash Need

CEO Tim Chen of, a credit card comparison site, also compared three options for getting emergency cash. His scenario involved needing $150 to pay a power bill so your power would not get cut off. He examined the costs of a high-interest credit card, a payday loan, and overdraft fees.

Obviously, the credit card was the “best option,” but the payday loan turned out to be a better option than the overdraft protection. If you have a credit card or a high enough credit score to get a card, you should go that route first. Unfortunately, many people over-drafting checking accounts don’t have that option. If you’re one of them, try and get a longer-term personal loan 24 months or so with a low interest rate. If that’s not possible consider a payday loan, but only after you’ve exhausted the other, less expensive options.

Opt Out of “Overdraft” or “Bounce Protection”

Your bank is legally required to inform you of overdraft coverage, but some don’t. So you may not know you have it until you overdraft your account and get hit with a big fee. If you’re not sure if you have it, call your bank and if you do cancel it. Instead, set up true protection by linking your account to a savings account or credit card.

This will help you avoid overdraft fees on ATM and debit or check card transactions. The card will simply be declined if no money is available.

When and if you need emergency cash due to a shortfall, you can use a credit card or a personal loan.

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