“Having a credit card is great!” said the naïve and probably financially doomed college student as he boasted about his newly opened revolving debt account. Check that same student a few years down the line and he’ll surely be singing a different tune. Debt in any form is a deceptive financial instrument. It bodes some benefits, such as allowing big ticket item purchases now, as well as adds to your credit score mix. But unless you are knowledgeable in debt management, any debt balance can easily turn into an increasing money drain.
Financial institutions are in the business of making money. Yes, they offer you a secure place to stash your money. They lure you in with all the benefits, such as access to your cash through a debit card, and quicker access to your paycheck via direct deposit, and the list goes on.
But the caveat is that they are holding your hard earned money for a fee! Yes, you are paying them to get access to the money you earned. I could digress here and go into how jobs are in cahoots with banks offering you discounted fees for banking at specific institutions and so on. Why can’t jobs just pay us in cash? But that’s a question for another time.
How It All Works.
Many banks charge fees if you have a checking or savings account with them. This fee may be waived by maintaining a specified daily bank balance (let’s say no less than $5,000 on a daily basis), or setting up a monthly direct deposit. This is an incentive for you to maintain a sizable balance and/or steady activity in your account that the bank can rely upon. Why you may ask?
They want to mitigate their risk. Even though bank activity is not listed on your credit report, unless it is a charged off item, bad banking habits are noted and may prevent you from opening accounts with other banks. Establish good banking practices early and be consistent.
Banks offer varied features to help you manage your account. One such feature to keep your account stable and prevent excessive overdraft fees is the overdraft protection option. This allows you to link a backup account to your checking account. If there is a situation where unexpected charges hit your bank account and are larger than the available balance, the bank will automatically look to the secondary account to get the overage difference. Instead of charging you a non-sufficient funds (NSF) fee, usually whopping $35 or more dollars, for each transaction that cause your account to go over your limit. In comparison, they will only charge a third of that fee for them transferring the money from your backup account.
The backup account can be a checking account, savings account, a credit card, or a line of credit (overdraft LOC or home equity LOC) at the current institution or elsewhere. Many find this is a great feature to help save time and effort in managing their bank balance. But before you link that credit card as the backup account, here are a few things to consider.
The Hidden Fees
In linking a bank account or a credit card account to your checking account for reserves transfer, it may look like a simple apples-to-apples comparison. But one is not like the other. A bank account has funds available, while a credit card has a set limit. When we use money from a bank account the available balance is reduced by the amount used. While when we use a credit card, whatever we used is added on as a debt owed. This credit card balance is now being charged an Annual Percent Rate (APR) financing fee, a rate that is significantly more than the savings rates offered.
APRs are determined based on the credit score of the applicant and can range from a low of 9.9% to a 24.9% rate, with the higher credit scores garnering the lower interest rate. According to Value Penguin, the national average APR ranged from 12 – 16%. Credit cards often have a penalty APR rate. This is typically the highest allowable interest rate a credit card can charge of 29.99%. The penalty rate comes into play when you mess up, for example you miss a monthly payment or go over your credit limit.
Along with the basic financing rate on purchases, credit cards often charge higher cash advance rates. A credit card cash advance allows the account holder to use the credit card like a regular debit card. They can withdraw money from their credit card account at banks and ATMS, but it will cost them. The cash advance rate is the rate that is applied when your credit card is used as the backup account for your overdraft protection. On average, the cash advance rate is 24.24% but can be as high as 36%. Along with a one-time transaction fee of 3 – 5%.
The credit card fees are on top of the overdraft fees the bank will charge for having to transfer the funds. The transfer fees are $5 on average.
What’s the Alternative?
As you can see, there are many fees and financing rates associated with using your credit card as a backup funding source for overdrafts to your bank account. In this respect, any funds transferred from your credit card to your bank account is essentially a loan, which makes it subject to interest rates and servicing fees. Not the best option, since you’re being charged on both ends (from your credit card and from your bank).
If you determine that overdraft protection is the right option for you, then sign up with your institution (per law, overdraft protection is no longer automatically added). The best secondary funding source is another checking or savings account. This way you would only pay one fee for any errors in judgement that causes your account to get overdrawn.
Typically when a bank account has frequent overdrafts, it is due to overspending or some other funds mismanagement. Create a budget and monitor your spending as well as check your bank account often. Most, if not all, banks and credit unions have online banking and/or apps that make keeping on top of your account easy.
Let’s stop making the banks rich. “A 2007 study by the Center for Responsible Lending said consumers are paying fees of $17.5 billion annually — on automatic overdraft loans of $15.8 billion per year.” I had to learn this the hard way. One month I paid over $400 in overdraft fees alone! I was paying for the convenience of charging more than what I had in the bank without the embarrassment of having a returned check or declined card.
If you find that you’re often being charged the high non-sufficient funds (NSF) fee even though you have money available in another account (such as a savings account), then signing up for overdraft protection may help. Choose the option that works best for your particular situation, and helps you manage and maintain your hard earned cash.