Consumers struggling with holiday spending hangovers may want to reconsider resorting to overdrafts on their checking accounts.

Banks often market overdraft programs as a way for customers to smooth out occasional budgeting problems. But many consumers don’t understand how they work and end up using overdrafts as a kind of high-cost credit, according to a new report from the Pew Charitable Trusts.

An overdraft occurs when you spend more than you have in your checking account, but your bank allows the payment to go through and charges you a fee. The fees vary, but big banks typically charge about $35. The Consumer Financial Protection Bureau recently estimated that consumers pay about $17 billion in such fees each year.

Banks’ overdraft revenue tends to rise each quarter of the calendar year before dropping again in the first quarter, suggesting that consumers may be crunched for cash and particularly vulnerable to such fees at the end of the year, said Thaddeus King, an officer with Pew’s consumer finance project.

The federal government requires consumers to give permission by “opting in” to overdraft coverage for debit card purchases and ATM withdrawals. If they don’t opt in and they attempt a debit card purchase or ATM withdrawal that exceeds their balance, the transaction is declined without a fee.

But many consumers — nearly 3 in 4, according to Pew’s finding — don’t realize they have a choice. Among those who have overdrawn their accounts in the past 12 months, Pew found, more than half have done it at least three times.

Customers’ understanding of how overdraft coverage works is low, even among those who have spoken to their bank about it, the report found. That suggests that banks’ communication about overdraft programs is ineffective, according to the report.

Customers “don’t seem to understand that when you opt out, you don’t pay the fee,” King said. He called that finding “somewhat disheartening.”

Pew suggested that many consumers would benefit if banks were instead able to offer lower cost, small installment loans with clear rules to protect borrowers. Such loans could be safely made if they were capped at no more than 5 percent of the borrower’s paycheck, Pew said. Many banks and credit unions have said they would be open to making such loans if they were given clear guidelines from regulators, King said.

Consumer Reports notes that some big banks — such as Bank of America and Chase — have “lower risk” accounts that don’t offer overdraft coverage. It’s also worth asking about other consumer-friendly policies when shopping for a bank account.

Consumers can change their minds and drop overdraft coverage at any time, according to the Consumer Bankers Association, a trade group for retail banks.

If you do choose coverage, the Consumer Financial Protection Bureau suggests setting up low-balance alerts on your account so that you receive a text or e-mail when your account drops below a certain level. Also, most banks now offer apps that make it easy to check your balance, so you can hold off if funds are tight.

You can also set up an overdraft transfer by linking your checking account to a savings account

 

Ann Carrns writes for the New York Times.