Many banks actively encourage their clients with low balances to overdraw their accounts. That means, if
customer writes a check or uses her debit card and has insufficient funds in account, bank clears check by granting a temporary overdraft (a short-term loan), up to a specific limit. The customer is saved from problems of bounced checks or interrupted shopping sprees. Sounds like a good deal for customers, right? That's what banks say. They claim overdrafts are an added convenience to customers.
The truth is, they're often a very bad deal for customers. Here's why.
When a bank grants a regular line of credit, interest charged may be up to say, 20% or so. However, for overdrafts, banks don't charge interest -- they charge a flat fee on each transaction. A fee that does not depend on value of transaction.
Let's see how that works. Overdraft plans fees may be as high as $35 per check. We'll assume a more conservative fee of $20 per check. If you have four checks totaling $200 that have insufficient funds against them and bank automatically activates overdraft and clears those checks, you will owe $80 in overdraft charges.
Unlike revolving lines of credit which you can repay at your convenience, an overdraft has to be settled in just a few days. Let's say bank allows you to run overdraft for 14 days.
A loan of $200 for 14 days incurring charges of $80 translates into an Annual Percentage Rate (APR) of 1043%!
