Want to Buy a $37 Soda?

Pay with a debit card and that refreshing soda on a hot day may give your wallet chills. Because of the way that most banks process debit card transactions, a $2.00 soda can generate $35 in bank fees. In this alert, we’ll highlight basic steps consumers should take to avoid the pernicious cycle of overdrafts and bank fees. 

How Overdraft Fees Work

Most consumers expect that when they use their debit card, their bank will decline a transaction if it exceeds the balance of their account. Recent news articles point to the fact that banks now regularly approve debit card purchases that will result in a negative account balance in order to tack on overdraft fees. The result? By allowing you to make a $2.00 purchase at the corner store, the bank stands to earn as much as $35 in fees. 

To make matters even worse, many banks maximize fees by ordering the sequence of withdrawals to pay the largest transactions first.  So, for example, let’s say that you have $500 in your account.  If a $500 check and 5 small debit card purchases post today, the bank will pay the $500 check first.  By doing so, the 5 debit card purchases will each generate a separate fee, potentially totaling $175.  Given the frequency with which many consumers use their debit cards, it's quite easy to incur numerous overdraft fees in a single day.  Most banks have no limit on the number of overdraft fees charged in one day.

Many consumers are shifting from credit cards to debit cards as banks lower credit lines and close inactive accounts.  According to the Nilson Report, debit cards will be used in about 60 percent of card transactions in 2010.   As consumers shift to debit cards, banks stand to generate ever greater amounts of fee income.

Avoid Overdraft Fees: What Can Consumers Do?

Avoiding Nasty Fees. To avoid overdraft fees, make sure that you keep an accurate record of your account balance at all times. Make sure you get a receipt for every transaction and promptly record it in your checkbook register.  It’s very easy to forget to record a small debit card purchase that can result in a huge fee. You can also sign up for programs that automatically transfer money from savings accounts when accounts are overdrawn or apply for coverage from the bank's line of credit. These fees are generally lower than typical overdraft fees.

Paying Through the Hose. To make matters even worse, use your debit card at the gas pump, a hotel, or a restaurant, and the merchant may “block” a dollar amount greater than your actual purchase amount. This is because the final amount of the transaction is not known when your card is swiped. Your bank may then place a “hold” on the funds until the final transaction clears. The result? Your available balance for future transactions may be less than you think. (You generally will not even know the dollar amount of the “block”.) Some banks may impose a fee for debit transactions exceeding your available balance. 

Dump Your Debit Card. The best way to avoid these fees is to simply avoid debit cards altogether. We recommend that consumers never use (or even carry) debit cards because of their fraud risks and their limited consumer protections. When you open a new account, most banks will automatically issue a debit card to you instead of an ATM card.  However, your bank can replace your debit card with an “old-fashioned” ATM card. But you have to ask for one. 

Thieves have become increasingly sophisticated in gaining access to sensitive financial information. Databases of major retailers and restaurants have been compromised by hackers. Point-of-sale terminals have been surreptitiously retrofitted with card skimmers. Restaurant employees have secretly captured card information on hand-held card readers. If you have a debit card and your account information is compromised, funds can quickly be withdrawn from your bank account without your knowledge. Your account can be emptied, resulting in overdrafts, fees, and an inability to pay your bills. 

But I Love Paying With Plastic. If you enjoy the convenience of paying for your everyday purchases with plastic, consider opening a no-annual-fee credit card account with a small line of credit for those purchases. Be sure to promptly pay off your bill in full each month to avoid any fees and finance charges. We recommend that you do not use any credit cards on which you carry a balance for this purpose, as that would increase your finance charges.

The 8 Disadvantages of Debit Cards. To read more about why we recommend against carrying a debit card, read our Fact Sheet “Paper or Plastic: What's the Best Way to Pay?”. Our guide explains the eight reasons why you should not use a debit card. It also explains the advantages and disadvantages of paying by credit card, check, gift card, and check. Our guide is available at www.privacyrights.org/fs/fs32-paperplastic.htm.


Privacy Rights Clearinghouse, “Paper or Plastic: What's the Best Way to Pay?”  www.privacyrights.org/fs/fs32-paperplastic.htm

Center for Responsible Lending, “Debit Card Danger” www.responsiblelending.org/overdraft-loans/research-analysis/Debit-Card-Danger-report.pdf

Consumer Federation of America, “Sixteen Largest Bank Overdraft Fees and Terms” www.consumerfed.org/pdfs/overdraft_fee_report_09.pdf

New York Times, "Debit Card Trap" www.nytimes.com/2009/08/20/opinion/20thu1.html