Most people at some point in their lives have had an overdraftric ranging from a few hundred or even a few thousand (or more) pounds.
The amount involved varies, but the cost usually involves some form of charges for each time the facility is used. For many of us, an overdraft limit at a high street bank can be as much as we believe we can afford: in our everyday experience we may well exceed our overdraft limit, knowing that we pay the fee at the same time.
All this talk about banking and overdraft fees may lead you to believe that bank overdrafts are a necessary evil (or, at least, one of the necessary evils of modern banking). But, in reality, they should be seen as an expensive way of having money lent to you (in one form or another), rather than an extension of your salary (in a more stealth way).
The Basics: Why Overdraft Fees are So High
To understand why overdraft fees are high, it’s necessary, first of all, to examine the nature of overdrafts in more detail.
An overdraft can be taken out to help you out with a personal or loan expense. For example, say you have arranged to borrow money to set up a new business, but you’ve forgotten to secure enough collateral to cover the payday loan lender. If you don’t have enough money in your bank account to cover the money, you go to your bank and ask for a $1000 loan, and the bank agrees.
But the bank has to bear the risk of your defaulting on the loan by calling in an overdraft. The amount they cover is less than the $1000 you owed, because the bank charges an overdraft fee of $25 as part of the deal.
That’s their cost of lending the money.
That worked out in the above example is that the bank covers 100% of the “risk” assumed by the lender.
Over the course of a year, the bank might charge you 40% of the $1000 in overdraft fees plus somewhere between 5% to 10% of the $25 it covers, say 2.5%. That means that, over the course of one year, the best bank will have paid the company $75 in overdraft fees (100%), but Bank X might only have paid them $30.
The Other Way Around
The above makes overdraft fees expensive for the bank, but they’re still only doing half of the job they’ve got to do. The other way around is that, with overdrafts, the bank covers 100% of the risk.
That works out in a way too. Even without fees, it’s still a pretty safe deal for the bank. But now the bank is covered (not just 80% of it, as before).
So why are overdraft fees such a nuisance? Here’s why:
The best and most sensible way to avoid overdrafts altogether is – if you can afford to – keep a big enough account in your name that is bigger than the one your bank has allocated for you (they’ll happily process payments from there), and that is uncapped (have more than enough money than the value of the fees they will charge you). This will let you keep using your debit card and your overdraft without having to worry about being hit with any fees.
The AccFT Collection”, a consumer finance body, reckons that bank overdrafts are one of the most expensive household finance items – coming in at Number eight on their “cost of living chart” – only ahead of rent (though lower than mortgages!).
But it does go beyond overdraft fees in other costs on the cost of everyday banking. There are also payment protection insurance charges, where in the law you have to pay a percentage of your outstanding debt in the event of illness or unemployment. And then you might also consider the charges on cheque-writing, which is always a potential cost – even if you aren’t overdrawn any money.
The usefulness of banking has never diminished. And overdrafts – despite their name – have become a SEAMS of money in the household budget. But one major limit has been reached -the overdraft limit.
Bear in mind that I’m talking here about charging you the bank and not a business or commercial lender.
Can you see the problem now?
Overdrafts have become a necessary cost of many British families’ living standards and loan repayments.
The banks have a very clever system of charging – sizeable sometimes – and receiving – compensation for their actions. In other words, they profit from your over-draft losses. And the level of compensation is rising.
That is why banks are increasing the size of their overdraft fees by the thousands.