Calculating APR on an Overdraft Fee
Today’s Yahoo!Finance column looks at bank overdraft fees. Legislation pending in Congress would characterize overdraft fees as financing, and require financial institutions to show the fee as an annual interest rate (APR). Because these overdraft loans are short and the fees are high, they resulting APRs are triple-digit figures or higher. Here’s how I calculated the APR for the example in the story, in case you want to figure out how to do it for an overdraft fee you incurred.
In my example, the consumer thinks he has $1,300 in his account, but he only has $1,150. He conducts six debit transactions totaling $180, and then pays his rent, for $1,100. He’s overdrawn the account by $130.
Bob’s transactions arrive in one batch at the bank. Instead of paying the six transactions and charging a single overdraft fee on the rent check, the bank pays the rent check first, followed by one transaction for $50. It then provides overdraft loans for the other five payments, so Bob incurs five separate fees of $34 each – or $170.
Two weeks later, Bob deposits his paycheck, and the bank gets its money back. Bottom line: When Bob pays $170 for a two-week loan of $130, the annual percentage rate comes out to 3,400 percent.
Here’s the math:
To figure out the annualized charge, multiply the two-week interest charge, $170, by 26 two-week periods per year (170 x 26 = 4420)
To get the annual interest rate, divide the annualized charge by the loan amount and multiply by 100 (4420/130 = 34 x 100 = 3400%
If he paid the overdraft loan back in one week instead of two, you would multiply by 52 instead of 26 to get the annualized charge. If it took a month, you’d multiply by 12.
I’d welcome your stories about banks and overdraft fees. Comment here or email me at laura at laurarowley dot com.
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July 27th, 2007 at 7:40 am
On your calculation of interest you may want to factor in that they also charge you interest on the balance, usually a significant amount over prime. I believe loan sharks charge 10 points a week (or so they did in Rounders), with compounding, which is about 14,100%, if my math is correct.
-FinanceGuy
July 27th, 2007 at 8:02 am
The bank entices you with a 0% for 8 months for your credit card balance transfer. You take advantage of such a good deal. The account is linked to my checking accounts at the institution. My wife errs in writing a check slightly over the balance and overdraft is provided on the c/c. I see the debit, credit back the amount on the c/c next day and expect to pay interest for 1 day.
However, even though I replaced the funds the next day, the bank gets to choose how to treat this transaction. They treat the overdraft transfer as a new debit to the a/c with regular interst charges outside the Special rate although my balance has NOT changed. I will now be charged interest for this overdraft for the remainder of the 8 month “deal” and although I’ve complained they will not budge.
I believe this fits right in with your APR analysis and how banks are legally getting away with usurious practices.
July 28th, 2007 at 2:56 pm
I thought your article on Yahoo was well written and certainly talked about the consumer’s struggles with managing a checking account. A few quotes from your article and thoughts around them:
“Moreover, banks can legally manipulate the order in which they pay checks and debits to maximize fees.” Certainly banks have the ability to pick and choose what debits they do and do not cover. Usually, the assumption from the bank is that you as the consumer would rather have your rent check not bounce as opposed to that 8 dollar check you wrote to the gas station. While my personal opinion is that I’d love to see banks reach out to consumers for their direction on paying debits, some lending institutions are just too large and do not have the resources. I think the key to this whole thing is consistency. Consumers want to know their bank is going to consistently follow a policy, one that is clearly expressed in disclosures. Don’t forget, nearly every business out there has their own fees for bounced checks. I think banks would be dumb to miss an opportunity to be the one to collect the fee as opposed to agencies working on behalf of businesses in the collection process.
I think your bullet points at the bottom of the article are great and certainly will help educate customers on what their bank will and won’t do for them. Ultimately, consumers have to take their financial situation into their own hand to make it work.
Great article, thanks for the read!
“Like many consumers, Page didn’t maintain her checkbook register, relying on her online account balance — which didn’t factor in outstanding paper checks.” Isn’t this the fault of the consumer to maintain her checking information correctly? I think there are many people out there who made a mistake with their finances, but how does that make it okay for the consumer to fail but shift the blame to the bank? If I ate too much food, should I blame the grocery store for letting me buy too much? There has to be some accountability placed on the consumer.
“Clearly, the consumer who spends more than he or she has is at fault. But the scales may be tipped against them: The Check Clearing for the 21st Century Act, approved in 2004, allows banks to clear checks they receive more quickly than in the past. But the act doesn’t require financial institutions to credit deposits any faster.” I completely agree with your point here, that’s why I think you’re seeing banks move from the old “cut-off times for deposits” and into more real-time crediting. Many banks are trending to give instant credit to cash deposits, including in ATM transactions. But the ACH world still exists and checks need to be verified for funds at other banks.
“Consumer advocates would like to see banks provide a warning to consumers if a transaction would overdraw their account.” Usually with credit transactions, if funds are not available, the card will come back declined. But again, banks don’t have 100% of the information like consumers should. The biggest suggestion to improve overdrafting – educate consumers on how to better manage their finances. Until customers stop trying to “float funds” and make it to their next paycheck, we’ll continue to see these things occur.
July 29th, 2007 at 6:45 pm
i recently have been VICTIMIZED by banks and there overdraft fees. I have a business checking account and a personal checking account that i can transfer funds from either account to help cover costs. Since I dont have an ATM/Debit Card for my business account I usually keep my balance low in my personal to avoid being surprised if someone steals my ATM/DEBIT card and goes out and charges things. ANyways the story goes like this…I call up a local florist and order flowers to have sent to my fiancé at work. The total comes to 203.98 for three dozen roses…ok I transfer the funds to cover that amount as well as I have money in there to cover my other atm transactions ive already made over the weekend. This being Monday. Well the florist somehow accidentally charges me twice for the flowers. I dont notice till Wednesday morning that this happened on monday..well surprise suprise. My bank has bounced BUT paid all my other ATM/Debit Transactions from the weekend now and conveniently charged me 30 dollars per overdraft totaling to $240.00 while they still have the funds on hold for $407 and some odd change for the double charge for the flowers. SO i call the florists to get the story on why they did that…call the bank they say they need to have my debit card information and transaction info faxed over on the florists letterhead explaining only the one charge was valid. Now I need to get reimbursed for the overdrafts. Bank says i need to file a claim…and in three business days I will either get a letter explaining the charges were not reversed or i would see credit back into my account. Well I got the letter that they are not responsible for the overdraft charges and that I need to contact the vendor that overcharged me to get reimbursed for my overdrafts…WHAT KINDA BULL is that? Banks are scandalous.
August 13th, 2007 at 2:59 pm
The last time I looked, banks were not a non-profit business. It is because of lazy consumers that these fees have escalated so much in the last ten years, and because banks rely so much on fee income, we have only ourselves to blame.
We have so many tools at our disposal to ensure that our checking accounts balance (internet banking, bank by phone, ATM’s, monthly statements) that I find it funny and sad when people complain that the bank should have called me when I became overdrawn. I doubt very much that a large bank like Bank of America or Chase has the resources to contact each customer that has overdrawn their account to ask them to make a deposit.
We, as a society, take no accountability for our actions. We want to blame someone else for our mistakes. I do not disagree that the fees charged by banks have gotten so high it’s ridiculous. But that is our fault. They charge it because we have become dependant on their so called “services”. Banks call these fees “service charges” or “convenience charges”, years ago they were called penalties for overdrawing your account. And since they renamed these fees, we as consumers bought it.
Balancing a checkbook does not require a masters in quantum physics, all you need to know how to do is add and subtract.
August 21st, 2007 at 1:44 pm
I’m sorry, but this specious argument is also being used to justify Payday loans’ super high fees and interest, while they claim the banks charge even higher rates. But these are not the same fees; Case in point – Payday loan companies use bounced-check fees as a collection tool, redepositing checks 8 or 10 times to pound a delinquent customers with hundreds of dollars in fees. They loudly claim to be cheaper than banks while they quietly collude with those same banks at customer’s expense.
Payday Loan companies want to encourage borrowing, they entice people with easy credit and quick transactions with the understanding up-front that fees are just a small part of the convenience. But banks implemented (in the beginning anyway) overdraft fees, check bouncing fees and the like as a dis-incentive. They existed to penalize bad check writers for what are essentially unauthorized loans vis-a-vis hot checks.
If they are the same, it’s only that the poor customer is out a lot of money either way, which I can say from personal experience can be a painful lesson. Are they morally equivalent? I don’t think so.
April 28th, 2008 at 11:14 pm
Well check this out. I own a small business in California. It has been so hard to get any type of back up money and or loan for my business. So I have to allow the bank to pay the checks and charge my account the overdraft fee of $30.00 each time. So in 2007 I started to keep tract of these fees as overdraft fees in the profit and loss statements. So I found 12, 865.00 of overdraft fees in one year. It is sick, yes my business generates approx. 390,000 per year but not having any cash flow funds makes a huge dent in my profits and give the banks a pretty penny with the efforts of my employees and myself. It is hard to run a small business and there seems to be no help in sight. I will keep on doing my everyday things but it does get way difficult at times. I found a bank website that never charges an overdraft fee for a fee of $19.95 a month this to me is a lot better than the $1200 a month I am paying now so I think I will give them a try and see if it works, specially for the small amount that sometime are 10 bucks and I get a $30.00 fee. What a JOKE!!. The website is http://www.Free-Overdraft.com I don’t know if it is any good but I will give it a try. If any of you have a suggestion for me on how to stop this craziness please email me at anafeb19@yahoo.com.
April 28th, 2008 at 11:28 pm
P.S. I do not mind the fees but I do believe the checks should be paid from small to large amounts not the other way around for banks to be able to profit more on small business like ours. Also believe it or not we are writting checks almost every day in a small business an the books are usually done by a bookkeeper at another location out of the place of the store where I write the checks when necessary and as we all know the month goes by so fast that it seems one never stops writting checks when a person is in business, suppliers, employees, utilities, car payments rent, ect., ect. So if the bank have to charge a fee does it have to be $30.00 bucks, come on it is too much. I remember about eight years ago Washington Mutual only charge $12.00. This is more reasonable unfortunately those days are gone. The funny thing is I cannot charge my customer any more because I will be out of business not the banks because they all charge the same and they will not compete in that way. Perhaps I should talk to all my fellow dry cleaners and we should all charge the same no matter what the quality, It would never work.
October 9th, 2009 at 4:36 pm
[...] is a previous post on how to avoid overdraft fees, and one on how to figure out what you’re paying on an APR basis for your overdraft “loan.” (I show how someone can pay 3400 percent interest on a [...]
March 6th, 2010 at 7:29 am
Dear Laura,
What bank do you have for your checking acct. that offers
3.5 percent if you use your debit card 10 times per month??
I want this bank, too !!!!!!!!!!!!
Spokane, Washington
Hi Spokane: I found a local bank in Arkansas willing to take out-of-state deposits. To find a high-interest checking account, go to checkingfinder.com. Good luck!