Apparently, when you have a debit card from most major banks, it doesn’t actually deny you funds when you run out of money in your account. Instead, the bank “lends” you money without your knowledge or consent, and then charges “interest” at an effective rate of up to 4,000%. I was unaware of this multibillion-dollar scam (which is still perfectly legal) until my best friend got hit with $500 in penalties for a $15 overdraft on his debit card. In his own words:  

On the 14th of August I received my first letter from the bank, telling me I was 15 dollars overdrawn on 5 small check card purchases on August 10th. For each of these I was charged a $25 fee for a penalty of $125. Of course, at that point I stopped making ATM purchases, but between August 10th and the 14th, I continued about my business and my ATM card contniued to work ALLOWING me to make purchases even though I was apparently already overdrawn at that point. So, I had an additional I think 8 purchases from the 10th to the 14th, when I received my first letter from the bank. Yesterday I received another letter from the bank itemizing four of these new purchases, of which they charged me $37 for the first, and $39 for the next three (not $25 anymore.) OK fine.

Today I went to the bank. I got the most recent update first. I have so far been charged $240 in penalties (in 4 days) , with two more “purchases” which haven’t gone through, which will add another $78 in penalities when they “clear.” I then spoke with a customer rep. I explained the situation to her. I explained that the reason that I signed up for debit card rather than credit was because I did not want the possibility of getting myself into trouble borrowing money. I did NOT WANT to be offered credit— this was the sole reason I signed up for the debit card. She said that it was my responsibility to keep track of my own balance and purchases, not the bank’s. I admitted that while that was true, the bank had a responsibility to make clear what I was agreeing to when I signed up with them. I said that it was explained to me that a debit card worked like a credit card as long as you had money in your account. It was never made clear to me that I would given credit without my agreeing to it and then charged credit at 1,800% INTEREST! I said that was insane, and exactly opposite to what I was trying to do to help my financial situation. If I had known that was what I was signing up for, I never would have signed up for that. I would have gotten a freakin’ credit card at 30% interest instead!!!! WHICH IS WHAT I DIDN’T WANT!

Right now, I owe the bank about $340, $100 for the purchases I made during the four days my account did not have money though they let me keep charging, plus $240 in penalties. In another day or two I might owe them close to $500. At present, when I go to an ATM and check my balance, it says zero dollars and I cannot make purchases. This is what I expected would have happened from August 10th to August 14th. However, during those four days the bank allowed me to keep charging and then charging me 1,800% interest on those purchases for four days!

My friend has been disputing the charges with the completely unhelpful branch managers at Citizens Bank in Buffalo, and in the meantime, has run up nearly $500 in debt because they are still charging him $37 per day. To keep him perpetually behind the eight-ball, when he now deposits a check in his account, the debit card machine tells him that the money is free to make purchases, but the bank applies the money to his overcharge penalties and then charges him a new penalty for the purchases he was misled into making.

He’s not alone in this Kafkaesque scenario. This July 29 article from MSN Money describes a nationwide problem (boldface emphasis mine):

A new survey of overdraft fees charged by the nation’s largest banks reveals that bankers are hiking fees, adding new fees, and shortening time limits to trigger fees when banks pay overdrafts and extend credit to families struggling to make ends meet.

The Consumer Federation of America blames the Federal Reserve for failing to protect consumers from escalating and multiplying overdraft fees.

Testifying before Congress recently in support of President Obama’s proposed Consumer Financial Protection Agency, the CFA said regulatory inaction in just this one area is costing hard-pressed consumers more than $17.5 billion during the worst economic downturn since the Great Depression….

The Consumer Federation of America’s survey can be read in PDF form here. As you can see, effective rates on a 7-day overdraft of $100 range from 1,820% to 3,848% at the top 16 banks. More tales of consumer woe can be found here. The New York Times also ran a staff editorial yesterday urging Congress to act:

Not many people would knowingly pay more than $35 for a cup of coffee. But far too many people are getting saddled — with no warning — with outsized bills for minor purchases, under a euphemistically labeled “overdraft protection program” that most major banks have adopted over the last 10 years.

Before that, most banks would simply have rejected debit transactions, without a fee, when the card holder’s account was empty. Now, they approve the purchase and tack on a hefty penalty for each transaction.

Moebs Services, a research company that has conducted studies for the government as well as some banks, reported recently that banks will earn more than $38 billion this year from overdraft and bounced-check fees. Moebs also estimates that 90 percent of that amount will be paid by the poorest 10 percent of the customer base….