Skip to main content

Search form

Consumers Increasingly Use Overdraft Loans as Expensive Credit

Monday, April 24, 2006

A nationwide survey shows that low-income people, single people, and many people of color are increasingly turning to borrowing money from financial institutions by over-drawing their checking accounts, racking up interest rates that can exceed 1,000 percent.

A telephone survey of 3,310 households done for the Center for Responsible Lending shows that a mere 16 percent of bank customers account for nearly three-quarters of all overdraft loans.

In other words, these people are effectively turning to overdraft loans (or "courtesy overdraft protection," as it's often called) as a line-of-credit. Before long, some are in over their head, reliant on this outrageously expensive way to obtain credit.

Here's how overdraft loans work: A financial institution covers a check, ATM withdrawal or debit card transaction even when the customer's account is empty. Typically, when the customer's next deposit hits the account, the bank grabs the overdraft amount plus a fee.

"A service created as a favor for customers has morphed into a harmful practice that traps vulnerable customers in debt," said Eric Halperin, a senior policy counsel at the Center. "Some banks now realize that trapping borrowers and charging them a $25 fee for a $20 overdraft loan is a pretty good scam."

Financial institutions are increasingly turning to fees to increase their income. Overdraft programs have grown almost 80 percent to 3,500 programs between 2003 and 2005. Of the estimated $10.3 billion in overdraft fees Americans pay each year, the survey indicates that $7.3 billion comes from repeat borrowers.

The Center for Responsible Lending calls on the Federal Reserve and other regulators to:

  • Require disclosure of the interest rates on overdraft loans.
  • Require borrowers' explicit consent before signing them up for these programs.
  • Require warnings when ATM and debit-card transactions will trigger fees and allow customers to opt out of the transactions.
  • Require institutions to report the numbers on their overdraft loans, which would show the impact of these programs on borrowers.
  • Prohibit repeated overdraft loan charges within a quarter.

"Regulators need to protect borrowers from getting caught in this cycle of debt," said Halperin. "Otherwise, there can be serious consequences for people's finances such as loss of their checking accounts or worse."

Contact: Sharon Reuss at 919-313-8527 or sharon.reuss@responsiblelending.org or Michael Flagg at 202-349-1862 or mike.flagg@responsiblelending.org.