Overdraft abuses are less common than they once were because of class action lawsuits against offenders – but they’re still going on.

Overdraft protection can be a useful tool on occasion. But for unwary consumers, it can be a virtual bludgeon and add hundreds of dollars to a single small transaction.

While some of these practices are legal from a technical standpoint, there are some behaviors in which banks and credit unions have engaged that courts have ruled cross the line from overdraft “protection” to overdraft abuses. These include deceptive, confusing policies and the intentional re-ordering of transactions in ways designed to maximize the number of overdraft fees that can be charged.

Overdraft Protection: History and Explanation

An overdraft is essentially a very short-term loan, for which a usurious rate of interest is charged. When a consumer accidentally overdraws an account and there is no backup source of funding, the institution advances funds to cover the transaction, tacking on a hefty fee (usually $35 to $45).

The practice of overdraft protection existed as early as the late 1720s. It was set up by the Royal Bank of Scotland (RBS), which had only recently been chartered by the British Crown, for the benefit of an important merchant named William Hogg. He had been having difficulty balancing his books because of late payments from his customers. The RBS agreed to extend Hogg a line of credit in the amount of £1,000 (approximately $174,000 in current U.S. dollars) in order to enable him to pay his expenses before receiving payment.

Hogg was the first beneficiary of the new overdraft system, which spread across the British Empire, including the North American colonies, within a few decades. As the Industrial Revolution got underway, it was necessary for newly-formed enterprises to have easy access to credit in order to get established without the need of taking out loans on assets they didn’t always have. 18th-Century Scottish philosopher and economist David Hume described the practice of overdraft as “one of the most ingenious ideas that has been executed in commerce.”

Reasons for overdrafts that are most likely to affect an individual consumer include:

• Inaccurate account records: a consumer fails to note all activity on their account and negligently spends more than is in the account.
• Hold on a deposit: a consumer deposits a check, but the bank or credit union places a hold on it, meaning the funds are not immediately available.
• Unexpected withdrawals: a consumer has authorized automatic withdrawals for specific payments for a one-time purpose or recurring service such as utilities or insurance premiums. It may also occur as a result of wage garnishment by tax authorities or other creditor.
• Returned check deposit: a consumer deposits a check that fails to clear, resulting in a chargeback.
• Unexpected fees: banks and credit unions may charge fees for any number of reasons, such as “maintenance fees” for failure to maintain a minimum balance. This can cause an account balance to be less than expected.
• ATM overdraft: Banks and credit unions may allow consumers to make automatic cash withdrawals even when sufficient funds are not available. Since 2010, the law requires that consumers must explicitly grant the bank or credit union permission by “opting in” to such a program.

This last form of overdraft is the issue at the heart of recent lawsuits against financial institutions regarding overdraft abuses.

“Actual Balance” vs. “Available Balance”

This is one bone of contention when it comes to overdraft abuses. In this age of digital banking when people can easily check their balances on their cell phones, what they usually see may be the “actual balance.” However, because of pending transactions that have not yet cleared or been posted, that “actual balance” may be more than the “available balance” – and the latter may be used to determine whether or not the consumer will be charged an overdraft fee. The “available balance” is the amount that exists in the account minus pending transactions that have not yet posted.

For example, Joe has $1,000 in his account. Previously, he set up an automatic withdrawal (ACH) for his insurance payment of $60, which is scheduled for the 5th of the month. However, that transaction does not actually go through until 2 days later – so on the 6th, his actual balance will still show as being $1,000, but his available balance would be $940. If Joe makes a $950 purchase on the 6th, he would be overdrawn by $10 – and would incur an overdraft fee.

Overdraft Abuses – Reordering Transactions

Here is where consumers who are hit with overdraft fees may find themselves with a cause of action to bring a lawsuit. It is an egregious practice that a number of banks and credit unions have used in order to maximize the number of fees they can charge to depositors.

According to a 2015 study by the Pew Charitable Trusts, approximately half of financial institutions process transactions out of order so as to be able to charge multiple overdraft fees. Here is an example of how it works: Sue has $500 in her account. She writes five small checks for $50 each, then later writes one large check for $400. Had her bank processed all of those transactions in order, she would have incurred only one overdraft fee for the $400 check. Instead, her bank processes the large check first, thus ensuring that three of the $50 checks will bounce – and instead of one overdraft fee, Sue winds up paying three.

Are Overdraft Abuses Always Intentional?

Not necessarily. For example, with an ATM transaction made at the local grocer or hardware store, those funds are withdrawn immediately. However, sometimes they are not.

Suppose you stop at a filling station to gas up your little sedan and use your ATM card at the pump. The filling station, not knowing whether you are driving a Smart Fortwo or a Hummer 2, assumes the latter and places a $100 hold against your account. That will temporarily reduce your available balance by $100 – and if another transaction comes in during that time or your balance is less than $100, you will be hit with an overdraft fee. (According to a report from the Pew Charitable Trusts published in 2014, over 90 percent of overdraft fees result from transactions of $50 or less.)

ACH payments are another problem, because typically, these take the longest to get posted to a depositor’s account. ACH transactions are also generally processed overnight in a batch with other transactions, and there is little consistency from one bank to another as to deadlines, what transactions may be included and the order in which they are processed. The result is that money is taken out of the consumer’s account when it is least expected.

This all causes a great deal of confusion, and while some say it is unfair and unethical, it may also be illegal. Furthermore, this chaos works in favor of banks and credit unions, which made over $32 billion in overdraft fees in 2015 alone – giving these institutions little incentive to see the system changed.

Unfairly Targeting the Most Vulnerable

Research by the Pew Charitable Trust also indicates that overdraft abuses and egregious fees primarily target those who can least afford it. These fees fall disproportionately on younger, low-income people of color. According to the aforementioned studies, the consumer most likely to be hit with multiple overdraft fee is under the age of 25, earns under $40,000 per year, and is African-American or Hispanic.

What is Being Done About Overdraft Abuses?

It is small wonder that overdraft abuses have resulted in a great deal of litigation in recent years. The good news is that in the majority of cases, juries have sided with plaintiffs. As a result, banks and credit unions have been forced to repay in excess of $1 billion to consumers who allege having been charged improper overdraft fees.

The federal government is also taking a hard look at the banking industry and the way it assesses overdraft fees. One step forward was taken in 2010 with the enactment of the “Opt-in Rule,” mentioned above, which requires financial institutions to get permission in writing from depositors before enrolling them in an overdraft protection program.

The law requires that:

• depositors be provided with a clear explanation of overdraft policies and the exact amount of any fees for this service
• the opt-in agreement is specific to the overdraft protection program (it cannot be part of any other agreement) or serve any other purpose
• the opt-in agreement cannot contain a pre-selected checked box
• the depositor’s account cannot be subject to different terms if s/he chooses not to participate in said overdraft protection

If a customer does not opt-in to overdraft protection and attempts to make a purchase or other transaction against insufficient funds, the bank can still decline the transaction, but it may not charge a fee.

The Office of the Comptroller of Currency has also been looking into alleged overdraft abuses, suggesting that new, updated regulations may be coming in the future.

A current class action lawsuit investigation is targeting several institutions for potentially abusive overdraft practices. Digital Federal Credit Union, SECU of North Carolina, PenFed, BECU, and many others are all suspected of manipulating their overdraft policies at the expense of their members.

If you were charged unfair overdraft fees by your bank or credit union, you could be eligible to participate in a FREE class action lawsuit investigation. If you qualify, an attorney will contact you to discuss the details of your potential case at no charge to you.

Fill out the form on this page now for a free, immediate, and confidential case evaluation.

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This article is not legal advice. It is presented
for informational purposes only.