Wednesday, September 9, 2009

Debit Cards Again

There's an article today from the New York Times about debit cards, which is fitting since I wrote about credit cards versus debit cards a few weeks ago. The basic idea: Debit cards used to be a good way for people to manage their money, since you couldn't spend more than what you had in your account... or so you thought. This forced budgeting is a big reason why debit cards became so popular, but banks have come to realize what a huge amount of profit they can make on debit card overdraft fees. Instead of declining a purchase for insufficient funds, banks will let the transaction through, in exchange for a fee of up to $35. Sure, it's more convenient for customers, but that convenience sure comes with a hefty price. Imagine using your debit card to buy a $3 cup of coffee, only to find out your bank charged you $35 (the equivalent of nearly 12 cups of coffee) to buy that coffee because you were overdrawn.

It's not merely the huge fees that banks charge that is so riling. Consumers need to keep track of how much money is in their account, and if they spend more than they have, then they should be prepared to face the consequences. And frankly, if you don't have enough money in your account, you probably shouldn't be spending $3 on coffee anyway. Charging $35 is excessive, though, and if you were to treat it as interest and express it in percentage terms, the fee would be equivalent to an interest rate of thousands of percent! This would put even the most zealous loan shark to shame. (And guess what? The banks lobbied to make sure that these fees could not be treated as interest, saving them from revealing how usurious this practice really is.)

Here's the worst part, though: Not only will banks charge onerous overdraft charges on your debit card purchases, but they will purposefully reorder your transactions in order to maximize those fees. Say you have $50 in your account, and you buy a $5 sandwich, then buy a $2 coffee, then pay a $60 utility bill, in that order. Most people would think you would get hit with an overdraft fee only once, when you paid your bill, but that is wrong. Even though you paid the bill last, the bank will reorder the transactions so that the bill is paid first. This puts you at -$10. The bank charges you a $35 overdraft fee. Then it runs the $5 sandwich purchase through, putting your account at -$15. The bank charges you another $35 overdraft fee. Finally, it runs your $2 coffee purchase, putting your account at -$17. The bank charges you yet another $35 overdraft fee, for a total of $105 in fees. That's an easy extra $70 in profit.

I've always preferred credit cards over debit cards, and this plainly shows why. Furthermore, when you use a credit card, you also have more legal protection should your card ever get stolen. With a credit card, you are liable for no more than $50. With a debit card, you are liable for the entire balance. If a thief completely empties your bank account, you're out of luck.

The moral of the story? If you don't want to be at the mercy of the banks, don't give them power over your life. Use a credit card instead of a debit card and pay off the balance every month. Or better yet, use cash and cut out the banks entirely.

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