New Debit Card Rules

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Debit-card rules are changing. You won’t notice the difference if you keep a cushion in your checking account, maintain meticulous records of your balance and all pending transactions, and your bank never makes a mistake. Otherwise, pay attention.

Overdraft Opt-Out Is the New Default Mode

On August 15, 2010, the rules change. If you’d like your bank to authorize debit-card or ATM transactions even if you don’t have money in your checking account, then you’ll need to make arrangements ahead of time with your bank. That is, make a conscious decision to opt-in to an overdraft agreement. See information from the Federal Reserve on new overdraft rules for debit-card transactions. (The opt-in rule applied to new accounts opened on or after July 1, 2010 but will not apply to existing accounts until mid-August.)

Many banks are now touting the “convenience” of overdraft services and are helping customers to “avoid the embarrassment” of having a debit-card transaction declined. There can be hefty fees attached to these amenities so be forewarned.

First, check your bank’s website and then, talk to your banker if you decide you want to opt-in to overdraft services and fees, such as:

• “Overdraft Privilege” with an overdraft fee of $34 per incident plus $5 per day up to 24 days if the account isn’t brought to a positive balance within 10 business days after the first overdraft incident.
   
• “Overdraft Protection” with a transfer fee of $10 to move money from a savings accounts, line of credit, credit card, etc. linked to your checking account in order to cover the funds needed for a transaction.
   
• “Extended Overdraft" an extra fee of $30-40 for having an overdrawn balance after transactions have been covered.

If you opt-in, note that the bank has your approval but is not required to authorize a payment if you don’t have the funds at the precise moment of the transaction. If your account is active and you generally have money in your account, then it’s likely but not guaranteed that the bank will process the transaction (that is, pay the merchant) on your behalf.

Before, Automatic Opt-In Meant Automatic Fees

Prior to recent federal legislation, banks could automatically enroll their debit-card customers in an overdraft protection program. So, when you paid a merchant with your debit card or withdrew funds from the ATM but didn’t have enough money in your checking account to cover the transaction, the bank might authorize the transaction anyway.

This arrangement sounds innocent, even protective. Some financial institutions, traditional banks and credit unions alike, referred to the procedure of authorizing a transaction even if the cardholder didn’t have the funds as a “courtesy.” This word implies a favor, a good turn offered freely by a friend, especially thoughtful acquaintance, or a stranger performing a random act of kindness, not a service provided for a fee.

By fronting money to its customers, banks allowed both essential and non-essential transactions to be completed. In some cases, perhaps when paying the toll-road fee on the way to the hospital’s emergency department at a time that you didn’t have a pre-paid pass, coins, cash, or a credit card, the bank's actions would be appreciated. Very often, though, customers would have preferred to learn immediately about the shortage and stopped the transaction rather than incur bank fees.

Complicating matters:

• Because they hadn’t expressly approved of the overdraft coverage, customers didn’t realize that they had given banks the right to authorize charges; customers may have reasonably believed that transactions would be declined if funds weren't available.
   
• Banks reserved the right to process debit-card transactions not as they were presented according to a traditional timeline (that is chronological order) but in an order that triggered a series of overdrafts and accompanying fees at $30-40 per incident. (See Will’s article on how banks manipulated debit-card transactions.)
   
• On the other hand, some banks may have authorized transactions even if funds weren't available but refrained from charging overdraft fees if deposits cleared later in the day.
   
• Just one round of overdraft fees could place even a savvy customer in a deep financial hole, which could then lead to a series of cash shortages and more fees.

Good News with Warning

Good news: you’ll avoid overdraft fees and banks are not charging fees if transaction amounts are less than $5 or $10 (check with your bank to find out its threshold).

Avoiding overdraft fees sounds great. What’s unclear is whether banks will charge some other type of fee, perhaps an electronic-decline fee or non-sufficient-funds fee rather than an overdraft fee if a debit-card transaction is declined. Some banks are saying explicitly that such transactions will be declined and no fee will be charged; others don’t address this issue. I mention this possibility after getting hit with a "low-activity" fee on a "no maintenance fee" account.

The advantage of the opt-out arrangement is that you’ll immediately find out about a low-balance situation and should avoid overdraft fees at the same time. You can then refrain from making more debit-card transactions, add money to your checking account, or straighten out any problems with deposits.

What’s Not Covered by the New Rules

The new opt-in rules cover everyday, nonrecurring debit-card transactions and ATM withdrawals. They don’t apply to:

• Check payments
   
• Recurring debit card transactions
   
• Automatic bill pays
   
• Online banking bill pay or transactions using your checking account number

How to Protect Yourself from Overdraft Fees

• Carry cash. My mom and Philip both recommend carrying some cash for just-in-case situations.

• SchwabMoneyWise recommends paying cash for rather than using plastic for transactions less than $10.

• Sign up for bank alerts of low-balance or negative-balance situations.
   
• Use your credit card, not debit card, for transactions.
   
• Create a budget and track spending to make sure that you don't overdraw your account.
   
• Note when deposits will be credited to your account, and challenge bankers to credit your account as soon as possible rather than holding funds for a few to several days.

Embrace the Negative

I like the the negativity of words like nonsufficient funds (NSF) that condemns those (even me, in college) who failed to have enough money in an account to cover a transaction and encourages us to set our financial paths straight. Whether you opt-in or opt-out of overdraft coverage, don’t be seduced by words like convenience and courtesy.