Are Debit Cards Evil, Too?

This post is from GRS Staff Writer Adam Baker. In addition to writing for Get Rich Slowly, Baker blogs over at Man vs. Debt, where he often discusses traveling and the cost of living abroad.

A couple weeks ago, the New York Times featured an article entitled “Overspending on Debit Cards is a Boon for Banks“. While I usually favor personal finance blogs over the larger online media networks (call me partial), this piece was particularly compelling to me. It does an excellent job of shedding light on a topic that is positioned to be the next major debate in our government's quest for banking reform.

27 billion reasons the banks want you to overdraft
As many other sectors of the banking industry continue to under-perform, debit cards have stepped up to become an essential profit center for banks. Fees associated with overdrafting checking accounts are expected to exceed $27 billion this year. In comparison, the article predicts only $20.5 billion in credit card fees, which is likely to drop even further in the years ahead as recent government reform will require consumers to opt in to over-the-limit charges.

Note: The $20.5 billion does does not include interest on outstanding balances within the credit card industry. The comparison is only of the fees related to the use and limits of the different types of cards. If you were to take into account interest, this match wouldn't even be close. Credit cards profits demolish those of the debit card industry.

While the majority of the article is fantastic, in spots The New York Times tends to go out of its way to demonize debit cards as compared to credit cards.  For example:

According to [a 2008] FDIC study, a $27 overdraft fee that a customer repays in two weeks on a $20 debit purchase would incur an annual percentage rate of 3,520 percent. By contrast, penalty interest rates on credit cards generally run about 30 percent.

The math here is a little foggy. They calculate the APR assuming that the $27 overdraft is based only on the one $20 purchase, while basing the credit card fees on the entire balance on the card. Of course, if you went over the limit on your credit card on a $20 purchase and got charged $27 fee, the percentage would be very similar (usually even more with interest).

Fuzzy math aside, there's little doubt that the nature of these fees can be steep. The most severe problems tend to be when multiple smaller charges are allowed to pass through and each slapped with the same fee. The resulting chain of fees can quickly add up to hundreds of dollars.

J.D.'s note: Between the time Baker submitted this article and the time I've been able to publish it, there have actually been some changes! As Flexo at Consumerism Commentary noted yesterday, some banks are beginning to allow customers to opt out of overdraft protection — and the fees that come with it.

The “benefits” of overdrafting.
The banking industry continues to take the stance that the ability to overdraft is offered as a convenience or a benefit. They claim that allowing you to overdraft could actually prevent you from violating a contract, paying higher interest, or being charged with late-payment fees. In addition, you would avoid the embarrassment or hassle that could come with having your debit card rejected at the point-of-sale. From the New York Times article:

“Everyone should know how much they have in their account and manage their funds well to avoid those fees,” said Scott Talbott, chief lobbyist at the Financial Services Roundtable, an advocacy group for large financial institutions.

I completely agree that the end responsibility rests solely on the consumer. If I overdraft my account, I am the one responsible.  We shouldn't be searching for a scapegoat or shifting the blame.

At the same time, the issue becomes much more complicated when consumers are required to have overdrafting enabled on their accounts. Many are simply wanting the banks to be more clear and upfront with their fees, allow consumers to opt out of the so-called “benefits” of overdrafting, or at least be informed when making a purchase that the account has been overdrafted.

Should the government intervene?
Many point to the recent Credit CARD Act of 2009, which stipulates that consumers will soon have to opt in to allow the limits of their credit cards to be exceeded (and incur the fees). They suggest similar legislation should mandate that consumers be required to opt in to the process of overdrafting. At the very least, they want all banks to offer consumers the opportunity to opt out.

On the flip side, The New York Times provides evidence from economists who suggest that tighter government restrictions could cause a serious ripple effect in the banking industry. For a large percentage of banks, their profit margin is less than the amount they collect in fees related to overdrafts. Any restriction on collecting these fees would force banks to immediately make up this revenue elsewhere, and many have suggested monthly fees on checking accounts would be an inevitable result.

The problem seems to be primarily concentrated within a small percentage of the consumers who take advantage of these products:

Ninety-three percent of all overdraft charges come from 14 percent of bank customers who exceeded their balances five times or more in a year, the FDIC found in its survey.

Should the 86% of consumers that use debit and checking products responsibly pay monthly checking fees to support the individuals who struggle? Should we allow the banks to prey on the 14% who are struggling to handle their accounts responsibly, so that we can obtain the benefits of these products for free? Obviously, there is no simple answer.

Scummy banking practices
The New York Times article also details the practice of banks reordering transactions in situations when an overdraft occurs. For example, many banks will change the order of purchases to prioritize the largest transactions. The banks claim that many consumers would rather their larger bills, such as car, house, or utility payments, be paid first. However, there are ample cases in which tacking the smallest charges on last dramatically increases the number of overdraft charges. In fact, this practice actually maximizes the amount of fees the banks can collect.

J.D.'s note: Longer ago, I had first-hand experience with this chain of fees. The banks order your transactions in such a way as to cause multiple overdrafts, if they can. It's not fun when it happens to you. (Biking to the store the other day, I overheard a woman telling a friend that this very thing had just happened to her.)

In addition, last week The New York Times ran a follow-up article, “Hurry Up and Credit My Account“. This latest piece details the current regulations on how long and how often banks can hold your incoming deposits. Many accuse the larger institutions of taking advantages of loopholes to hold back deposits longer, thereby increasing the potential for overdraft fees.

In the two specific cases above, I have no problem with government intervention. I would support legislation that required banks to process all expenses in the order they were received (for better or worse) and required increased transparency and consistency on the placement of holds for incoming deposits.

Is debit the new credit?
I continue to return to one thing in this discussion. For me, once debit cards enable you to spend more than is available in your checking account, they become credit cards. It's really that simple, right? What happened to actual debit cards along the way?

Here in New Zealand, I have a true debit card. There is no Visa or Mastercard logo. I can't use it for online purchases. However, it is accepted at all point-of-sale vendors (and ATMs). What happens if I try to charge something for which no funds exist? It's rejected! Gasp!

I find the debit card situation here refreshing — both in theory and practice. What about you? What do you think about overdraft fees being such an essential profit-center for banks? Is this another industry where you would support government intervention? Share your thoughts below!

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Jay
Jay
11 years ago

Any instrument that allows you to spend more then you actually have is “credit”. With that credit, there will always be those who overextend themselves.

Alison
Alison
11 years ago

I was interested to read that you can overdraft on the debit cards with the logo– I live in the US and my debit card does not have a Visa/Mastercard logo at it, so I can use it at most ATMs and a lot of point of purchase locations but can’t overdraft. I’m meticulous about balancing my checkbook…

Chickybeth
Chickybeth
11 years ago

One of the scummiest tactics I have encountered was when I banked with Republic Bank. If you checked your balance (say at the ATM) your real balance would not show, but instead the amount shown would be your real balance PLUS the allowable overdraft amount. So, one time I overdrew my account because I thought my income tax refund had finally been deposited into my account because it about the same amount as the “overdraft protection” amount. It was truly slimy. That’s when I started balancing my account every couple of days and only going by what I have written… Read more »

Adam
Adam
11 years ago

I’m of the opinion that the govenment should not be regulating debit cards. If someone doesn’t like that the bank requires them to have overdraft protection, they should find a different bank.

I’ve noticed more places accepting EBT (Electronic Bank Transfer). I image those are like real debit cards that will get rejected if you go over, but I’m not sure, and I don’t know how to get EBT.

Alexandra
Alexandra
11 years ago

I think people need to be accountable for their own spending. Don’t overdraw from your account. Period. Then all these additional fees become moot.

I’d rather the government focus on more important things.

Derek
Derek
11 years ago

“The Golden Rule” will always prevail. (Golden Rule: he who has the gold makes the rules) These banking institutions have and control the financial world. As long as there are consumers who will choose to spend more than they have, these institutions will thrive on adding charges and taking everything they can get. I agree that a debit card ought not have the ability to overdraft more than what is in the account (I also don’t know how credit cards ever got to overdrafting more credit than they had allowed either, other than it was another way to charge more… Read more »

Sam
Sam
11 years ago

Because we use our debit cards for all day to day purchases* this is an issue for us. We also limit how much money we keep in the checking accounts tied to our debit cards (we use an allowance system for our day to day spending). As a result we originally had some trouble managing our debit cards and ran into the overdrafting problem. In order to avoid overdraft fees we link our primary checking with a small primary savings account ($500-$1000) and I review our online statements just about every day towards the 15th and last day of the… Read more »

EscapeVelocity
EscapeVelocity
11 years ago

I believe the verb form is “overdraw”….

My overdraft protection is in the form of transferring money from my money market account into my checking account, for which my credit union charges me $3 (and yes, if multiple things hit at the same time they will put in the largest one first). Is this what we’re talking about, or are banks actually lending money to make up the difference?

Foxie@CarsxGirl
11 years ago

Uh oh, you better watch out…. People no longer believe in personal responsibility these days. Oh no, now it’s everyone else’s fault as to why we can’t do what we want/we’re in debt/we can’t afford this or that/etc.

Seriously. Personal Responsibility. It’s not hard, I promise.

Chickybeth
Chickybeth
11 years ago

Condescending attitude aside…wouldn’t declining the sale at POS lead to better personal responsibility?

At least then you would know something had been entered incorrectly and could follow up with the bank right away instead of incurring fees before you know of the error.

Brenda
Brenda
11 years ago

I don’t think overdraft fees are scummy at all. They are a penalty for keeping poor tabs on your finances and over-spending. My ex gets hit with overdraft fees on his debit card a lot. Why? Because he keeps poor records of what he spent so he is never 100% sure of what’s in his account, and when he deposits a check, he assumes the money will be there the same or next day, which is usually untrue. He also can’t say no to certain frivolous purchases such as beer or cigarettes. The banks are in no way to blame… Read more »

Kim
Kim
11 years ago

Overdraft fees happen to the responsible too, because banks rearrange the order of deposits and withdrawals at night. Say you have $0 in the bank. You deposit $500 cash (so it credits immediately), and then 5 hours later make a $10 purchase at CVS. At night, banks tally up the day’s spending so that debits are calculated before deposits. Rearranged, your balance goes negative, then you’re slapped with overdraft fees, and then your deposit is credited. Sneaky, eh? When you’re living paycheck to paycheck, this happens all too often. There was an article about it in the Washington Post 2… Read more »

B
B
11 years ago

Overall I found this an interesting and provocative article. However, I think it’s misleading and not empirically right to claim the NYT is using “fuzzy math”. They are using different assumptions than you are and they come up with a different result. You can discuss your disagreement with their assumptions without sounding like a guy in a tinfoil hat. Nothing is wrong with the math; you’re disagreement is with the argument’s logic.

Mark Wolfinger
Mark Wolfinger
11 years ago

“Scummy banking practices
The New York Times article also details the practice of banks reordering transactions in situations when an overdraft occurs. ”

Scummy is too kind. These bankers are leeches at best.

If the bank honors all the transactions anyway – what difference does the sequence make?

The only difference is in the number of overdrafts.

This excuse of ‘more important’ drafts get paid first first is so blatantly despicable that I’m amazed they dare try to get away with that.

These are predatory lending practices and should be dealt with accordingly.

Jason
Jason
11 years ago

Yes to personal responsibility. That’s a given. However, consumer protection is one area where the Federal government does have a tradition of helping out the citizenry — and even their protections can get watered down! Slimy practices like chickybeth mentioned, in addition to ordering the overdrafted items to maximize profit, as mentioned in the article, can be viewed as things that need to be reformed. As a consumer, I would definitely like to be able to opt out of overdraft protection and just be outright denied a purchase. “Overdraft protection” has been a sham service just about forever — I… Read more »

Colleen
Colleen
11 years ago

JD, I like your comments, but I wish you would put them at the end as notes instead of in the middle of the other author’s work. I find that your comments really break the author’s flow and it always takes me a minute to re-orient myself after you’ve taken me out of the article.

Leah
Leah
11 years ago

@Adam: EBT stands for Electronic Benefit Transfer. It’s how foodstamps are processed now. Through the credit card scanning machines at checkout lines.

Four Pillars
Four Pillars
11 years ago

I don’t think the banks should be allowed to re-order the transactions. That doesn’t seem right.

As for the fees themselves – too bad. I have no idea why debit cards are so popular when credit cards are a far better alternative. Cash is still accepted at most institutions as well.

What did these idiots use before debit cards were invented? Were they better off then?

Jason
Jason
11 years ago

“credit cards are a far better alternative”

A better alternative for the credit card company’s bottom line, maybe 🙂

Little House
Little House
11 years ago

I’d have to agree with JD and say the reordering of the transactions is the scummiest thing banks do. Over a year ago, my husband and I had this same thing happen to us. The bank reordered our transactions and let a large transaction through. Then, a bunch of little ones were approved. We ended up with $330 in overdraft fees. Had the bank taken the transactions in the order spent, the largest transaction would have been last and it would have been declined, or worse case scenario, accepted with one overdraft fee of $30. The bank, instead, profited $300… Read more »

Heidi
Heidi
11 years ago

My new credit union does something I’ve never seen before, and that I find really scummy. They will overdraft you on your pending transactions. Say, for example, you have $50 in the bank and need gas. You go to the gas station, and because it’s cold and raining you decide to pay at the pump. Insert your debit card, put in $30 worth of gas, get your receipt and drive off on your merry way. You didn’t know it, but the gas pump put a hold on your account for $75. Even though that $75 is just a hold and… Read more »

Gryphon
Gryphon
11 years ago

This sort of thing is why I love my credit union. If I screw up, they will check my savings account and transfer the needed funds to checking in order to cover whatever I am trying to run on the debit card. Is a very handy feature, and they don’t charge me a cent for it. Only ever had this happen once, and it was because my lovely employer at the time was behind processing payroll. I didn’t even realize what had happened until I logged in to check my balances that evening. No hassle at all on my end.… Read more »

Ann
Ann
11 years ago

I’m going to echo all those who said personal responsibility. What ever happened to making a mistake and accepting the consequences of it?

And here’s another beautiful thing: choice. If you don’t like the practices of the bank you’re with, switch.

@Kim #12 – I’ve never heard of a bank re-ordering deposits. Maybe it’s time to take your business elsewhere.

Alex R
Alex R
11 years ago

It is frustrating when the place you depend on security of your money is the very people trying to nickel and dime you to death. I keep my account with Bank of America because they’re national making it easier when I travel. I like my credit union because of good service and strong rates.

Tyler Tervooren
Tyler Tervooren
11 years ago

This seems like another one of those examples where a disproportionate few may actually be propping up the ‘free’ and ‘low fee’ checking systems that the rest of us benefit from. Without them feeding the system, everyone might need to pony up to keep their accounts. On the other hand, there are no fewer than a million ways to solve any problem, so it seems likely that we could make the rules a lot more fair without harming anyone in the process. The debate over the cost of universal health care comes to mind as a similar topic, but I… Read more »

Kevin M
Kevin M
11 years ago

I’d rather have the banks charging people who deserve it (overdraw their accounts) than slap a monthly fee on everybody. I’m sick of the government over-regulating business to “protect” people from fees that are their fault.

I do agree that the deposit rules are ridiculous. Nearly everything is electronic these days, there should be no “holds” that last days.

Jack @ Master Your Card
Jack @ Master Your Card
11 years ago

Great write up – I’ve been covering the debit card stuff on my own blog, too and you pulled out some really interesting points from those articles. I noticed recently in the news that charge cards are rising in popularity, too. It’s like the best (or worst?) of both worlds – you can make purchases but have to pay it all off by the end of the month (can’t carry a balance). It seems like everyone fled from credit to debit and then the wily tactics followed – now small businesses are turning to charge cards and Chase is looking… Read more »

Vas
Vas
11 years ago

I think government’s should intervene on this. The government in Australia has intervened in the pay day lending industry I am pretty sure same in America. Allowing customers going into overdraft is basically the same as a customer taking out a payday loan. The benefits they are selling are exactly the benefits which payday lenders sell “The “benefits” of overdrafting. The banking industry continues to take the stance that the ability to overdraft is offered as a convenience or a benefit. They claim that allowing you to overdraft could actually prevent you from violating a contract, paying higher interest, or… Read more »

Jason
Jason
11 years ago

For the “personal responsibility” cheerleaders, everyone agrees with you. The problems come with the ways in which banks are handling your money in order to try and reap more profit with practices like “holding” your deposit (despite checks clearing electronically), the “debit hold” BS (always use “credit” at the gas pump and reordering withdrawls. Keep in mind that the economy is in the crapper, 10% of people are without work and it’s generally sour financial times out there, so it’s possible that there are a lot of “responsible” people who are just getting by and might be living check to… Read more »

Matt B.
Matt B.
11 years ago

I got a debit card to go with my ING Direct checking and savings accounts I opened last year. While I haven’t overdrafted based on a debit card purchase, I did do so paying a bill online — basically i forgot to transfer enough money from savings to checking. I think it ended up costing me 10 cents or something ridiculously low. It’s very nice to have an extra $500 I know I can potentially go over with and only pay a small financing charge on the amount, rather than an automatic $30 fee. I assume the same holds true… Read more »

Sarah T
Sarah T
11 years ago

I also once had an experience with being charged overdraft fees in a sketchy way — in this case, my statement balance appeared positive throughout, but I was still charged fees because of transaction ordering. It seems unfair to me, especially in this case where I was keeping a very close eye on my balance and was unable to tell from the information presented to me what they were doing. (I had to call them and get the customer service guy to show me the secret back-end log to find out; they did not refund the fees.)

Lazy Man and Money
Lazy Man and Money
11 years ago

Hmmm, almost sounds like you are implying credit cards are evil in the title. I suppose that’s a reasonable stance for Man vs. Debt to take, but many others find them an invaluable tool for saving an extra 2-5% on purchases.

(Granted it’s pretty rare to still have the 5% nowadays).

Mark Wolfinger
Mark Wolfinger
11 years ago

To Four Pillars:

Agree it’s customer’s fault.

But, some people are unable to do simple things.. Do they have to be punished so severely for being unable to balance a checkbook?

The bank’s practices are unconscionable.

Baker
Baker
11 years ago

@Alexandra: That’s a good point I didn’t mention directly. Any amount of time the government spends on this is distracting away form other issues. Adds a new dimension to justifying reform (at least right now). @Sam: Your story is very similar to my own. We LOVE our debit cards and still primarily use them. We’ve been fortunate not to struggle to much with this issue, although if a bank reordered my transactions, I’m not sure I could control myself. 😉 @B: Great point. By “fuzzy math”, I meant the logic behind the math was fuzzy. I should have been more… Read more »

jeffeb3
jeffeb3
11 years ago

I don’t think banks give you free checking so they can charge you fees. The more deposits they have, the more they can lend. Because of the way the lending regulation works, they can lend out $5,000 for every $1,000 in deposits, and earn 5.5% interest on the loan. Why would they charge you to keep money in your account? Removing these fees will at most increase the minimums on free checking, or they will use it as an excuse to charge you, when it’s not really justified. If you’re making 27.5% on my deposit, then I’m not paying you… Read more »

ra
ra
11 years ago

I recently over drafted by $.98 and I was charged $35. Real nice!

Peggy
Peggy
11 years ago

Debit cards in Canada work the same as in New Zealand. You can’t use them online, you can only use them where the facilities exist in stores (which is almost all of them) or at ATMs, and if you don’t have the money in your account for the purchase, you get told you have insufficient funds and, too bad so sad, no purchase for you.

ebyt
ebyt
11 years ago

I have an overdraft… I voluntarily signed up for it just in case. If I don’t go into it, there is no interest charged, and if I do go into it, I am charged interest based on the negative amount until money is deposited again. If you don’t have an overdraft, then in my opinion you need to be doubly sure what amount is in your account. I don’t like to go into my overdraft, but sometimes it happens. I know I am responsible for the interest I incur, and I am fine with that. Debit cards don’t have to… Read more »

Nathan
Nathan
11 years ago

The frustrating thing for me is that each bank has a different policy. My current bank is one of those that arranges the transactions for maximum benefit to them. My previous bank would always put deposits first. So, I could monitor my accounts, and if my wife’s account was about to overdraft, I could transfer some money to cover it. But with our current bank, it’s too late by the time I see it.

Cory Kaufman
Cory Kaufman
11 years ago

“In addition, you would avoid the embarrassment or hassle that could come with having your debit card rejected at the point-of-sale”

When I turned 18, I got my first debit card from a local bank. If I didn’t have enough cash in my account, the card would be rejected. Far from being an embarrassment or a hassle, I loved it! I’m sick of banks telling me what is a benefit to me.

Four Pillars
Four Pillars
11 years ago

@Jason – “credit cards are a far better alternative”

A better alternative for the credit card company’s bottom line, maybe

Yes, if you use credit cards irresponsibly. For the rest of us – CCs are a very useful tool.

Four Pillars
Four Pillars
11 years ago

@Mark W – To Four Pillars: Agree it’s customer’s fault. But, some people are unable to do simple things.. Do they have to be punished so severely for being unable to balance a checkbook? The bank’s practices are unconscionable. Regarding the bank’s practices – I agree. Re-ordering transactions should be illegal. As for people who can’t do simple things…I just don’t know. I suspect that most people who can’t balance a checkbook have the ability to do so but they are not interested or won’t make the time. I’m just not sure if regulation should be introduced to help that… Read more »

Tyler Karaszewski
Tyler Karaszewski
11 years ago

In response to the titular question: No.

They’re pretty much the most convenient money tool ever.

I have not overdrafted my checking account since years ago when I got my financial affairs in order and stopped living within a few dollars of a zero balance. Calling debit cards evil because you can overdraft your account with them is like calling cars evil because it’s easy to crash them when you’re drunk. The car (or card) is not encouraging any irresponsibility here, it’s entire on the shoulders of the operator.

Sharon
Sharon
11 years ago

I wouldn’t compare the debit to a credit card as much as I would compare it to writing a bad check.
We are really in an age of not taking responsibility.
We all make mistakes, but I don’t believe that’s where the majority of the money is made.
People today spend more than they have and wonder why it costs them.

partgypsy
partgypsy
11 years ago

I had not overdrafted in years, but had a flurry of them this spring. It was incredibly confusing to figure out what happened and what the multiple charges were for, as when you logged into our checking account we were getting overcharge fees when it showed we had a positive balance. (It took awhile but I think I remember from the explanation that again, transactions were not processed in the order that they were showed, and the overcharge fees then made subsequent small transactions have overcharge fees, starting a a domino effect. I was able to have a number of… Read more »

Martin
Martin
11 years ago

In many states, an overdraft fee for writing a bad check would be the least of your worries. If you overspend on your debit card and your rent check bounces, you could go to JAIL. In Georgia, it’s called deposit account fraud. If you get notice from the draftee and you don’t respond, fraudulent intent is presumed. Banks were doing this before debit cards even existed, and it is a valuable service. It’s only become an issue since people started using debit cards (irresponsibly) and incurring the fees more often. If I was worried that I might overdraft my account,… Read more »

Walter
Walter
11 years ago

What happened to the days when a purchase would be rejected if the CC account didn’t have enough funds in it? A return to that practice is what the government should push for as that would obviate a lot of the other regulations they wish to put into place.

Alexandra
Alexandra
11 years ago

I am pretty sure that everyone is aware that banks can require up to five business days for a cheque to “clear”. The timing can vary from bank to bank – it’s pretty simple to check what your own bank’s policy is. Just look at your account service statement.

We are aware of this fact, the bank has always been very clear about this, yet some people are still surprised that they have to wait? I don’t get why.

It’s obviously someone else’s fault.

Tyler
Tyler
11 years ago

Agreed! Debit cards need to be and stay as “plastic currency”. Your debit card is worth the same amount that you have in your checking account – just in a different form.

David S
David S
11 years ago

I think we need to recognize that overdraft protection is just a fancy term for ‘loan’ and therefore should be subject to all the state and federal regulations that apply to loans.

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