You're at the ATM, looking to get cash out of your bank or credit union account. Before the money will come out, the screen gives you a warning like this: "This ATM charges a fee of $2 for this transaction. This is in addition to any fee your bank may charge. Do you wish to continue?"
You know what the deal is -- you have to pay a fee to get your money -- so you go ahead. You've made a well-informed choice to pay the modest fee.
But let's say you are trying to withdraw $20 more than you actually have in your checking account.
Does the machine then say, "Sorry, you don't have that much money in your account"?
Oftentimes, not. Your bank or credit union is happy to cover your overdraft -- for a hefty fee. You might be charged as much as $35 for the privilege of overdrawing by $20.
Financial institutions call it a convenience fee, but it's really a loan with an astronomical interest rate. On small overdrafts, the annual rate can run upwards of 400 percent or more -- higher than a pawnshop charges.
Banks will rake in $38.5 billion from overdraft fees this year, according to the research firm Moebs Services. Almost half comes from ATM or debit transactions, according to the Center for Responsible Lending. In those cases, it is possible to warn customers about the impending overdraft, notify them of the overdraft fee and give them the option of canceling.
But doing so would put a big crimp in a multibillion-dollar business. Seventy-nine percent of consumers who overdraw their accounts do so by mistake, according to academic research cited in a USA Today report.
In other words, this is a case where ignorance (by customers) is bliss (for financial institutions).
Customers often don't realize their accounts have this costly overdraft "protection." When they are notified, it may be in fine print or an easily overlooked insert in the monthly bill. Customers don't automatically get the option of rejecting the expensive "protection" when they open an account.
Customers don't have to be warned at the time of their electronic transaction that it will cause an overdraft. When a transaction requires an overdraft, customers don't have to be told what the fee will be. Customers may not have the option of telling their bank in advance to refuse any electronic transaction that requires an overdraft.
The Federal Reserve is working on new limits and disclosures for overdraft fees. Congress is considering legislation too. Earlier this year, it passed limits on charging exorbitant fees for going over the credit limit on a credit card.
Defenders of the overdraft fees say only a tiny minority of customers actually pay the charges. You can avoid them by properly managing your accounts. Responsible customers shouldn't have to subsidize the financially irresponsible ones.
But the financial institutions are literally banking on consumers' ignorance and desperation to extract billions of dollars they might not otherwise spend. Congress should make sure customers have understandable information about potentially huge overdraft fees, both in advance and at the time of electronic purchases, so they can make an informed decision.
BOTTOM LINE: Tighter disclosure rules on overdraft fees will help consumers make better decisions.