The average overdraft fee costs consumers $35 per breach, making it an inconvenient and frustrating part of day-to-day banking for many people. But some big banks — Capital One, Bank of America, Truist, US Bank and Wells Fargo — have recently taken steps to reduce or eliminate overdraft fees for their customers. In 2019, Discover also decided to remove fees on all of its bank accounts, including overdraft fees, and Ally Bank removed overdraft fees in 2021.
According to consumer financial protection bureau research, banks collectively earned more than $15 billion in overdraft fees in 2019, which means individual banks could potentially lose hundreds of millions of dollars if they stop charging overdraft fees. For example, Capital One’s decision to scrap overdraft fees will cost the company $150 million, according to a spokesperson.
So what’s in it for banks waiving these fees?
Why are banks removing or reducing overdraft fees?
“Overdraft fees are deeply unpopular with consumers, and consumers now have more choice,” says Leigh Phillips, CEO of fintech nonprofit SaverLife and chairman of the Consumer Advisory Board of the Consumer Financial Protection Bureau. “Previously, they only had mainstream options like banks and credit unions or fringe services like payday loans. Today, neobanks and challenger banks are creating services that suit a variety of consumers. .”
With the rise of these new, smaller banks, as well as online and mobile banking, the banking industry has had to find more ways to compete for new customers. Overdrafts can be stressful and expensive, and if a bank can help customers avoid these potentially large fees, that bank could be more attractive to consumers.
“What we’ve found is that when we make these kinds of changes, our customers notice it and potential customers notice it as well,” a Capital One spokesperson said. “We realized that these policies, although costly in the short term, pay off in the long term.”
Some financial institutions, such as Chime and SoFi, have gone so far as to offer consumers a certain amount of money – similar to a line of credit – that they can draw down if they overdraw their accounts. These features come free with qualifying account activity. For example, Chime’s SpotMe feature can give customers up to $200 to cover the cost of a transaction instead of overdrafts, and SoFi offers customers up to $50.
The current overdraft system
Overdraft fees often involve more than the one-time fee for overdrafting an account. Occasionally, a bank will charge overdraft fees multiple times a day if a customer continues to use their debit card without sufficient funds in their account, which can amount to hundreds of dollars. There may also be additional charges associated with a continuing negative balance, use of an overdraft protection transfer service, or use of an overdrawn line of credit. Ultimately, consumers can be responsible for substantial overdraft fees, making financial hardship even more difficult.
“Some consumers have a bad overdraft pattern, often because they made a mistake or didn’t get paid as expected,” Phillips says. “When they are paid again, a lot of it is used to pay overdraft fees. This is not sustainable, especially for people who are on the lower socioeconomic spectrum or who do not have a steady income, like people who work in the gig economy or have hourly jobs.”
When banks charge overdraft fees, they have a way of punishing people who are probably already in financial trouble. The coronavirus pandemic has highlighted this difficulty as people have had to adapt to new ways of working and making ends meet. Therefore, the trend of banks removing or reducing overdraft fees can be seen as a step forward for consumers who need help improving their financial situation.
“By making changes to our overdraft fee and insufficient funds policies, we’re giving customers the ability to better manage their cash flow, course-correct when needed, and support their growth and financial well-being.” said a Capital One spokesperson.
The decision to remove overdraft fees is good for consumers. Nevertheless, overdraft fees can be a relatively small source of income for a bank. For example, Capital One reported net income of $3.1 billion in the third quarter of 2021 alone. The $150 million the company says it is losing in overdraft fees represents about 4.8% of its total net income for the quarter. Compared to full year revenue, this percentage will drop dramatically.
How Consumers Can Evaluate and Avoid Overdraft Fees
Consumers struggling with harsh overdraft policies at their current bank may find out about banking products which do not have overdraft fees or give customers the option to turn it off, which means that a transaction will be declined if the account does not have sufficient funds. Consumers can also look for banks that alert customers when their account balance is low.
Since excessive overdraft fees can impede wealth creation, Phillips sees the trend of banks removing them as a positive and inclusive measure that allows more consumers to establish and maintain financial security.
“We are in a time where people need to participate in the mainstream of finance with equal access,” says Phillips.
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Chanelle Bessette writes for NerdWallet. Email: [email protected]
The article Why Banks Are Eliminating Overdraft Fees originally appeared on NerdWallet.