Overdraft and Check-Kiting Problems

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 What Is an Overdraft?

An overdraft occurs whenever a bank receives a check worth more than the cash in the account. If the bank pays the checks presented against the account before the checks deposited are collected, the result is an overdraft. A bank is not required to honor checks that exceed the current collected balance in the depositor’s account.

An overdraft is essentially an extension of credit from the bank that is granted when an account reaches zero. Overdrafts allow the account holder to continue withdrawing money even when the account has no funds or has insufficient funds to cover the withdrawal amount.

An overdraft allows customers to borrow a set amount of money from a bank. There is interest on the overdraft, and there is typically a fee per overdraft. At many banks, an overdraft fee may cost upwards of $35.

When accounts overdraft, a bank covers the payments a customer has made that would otherwise be rejected. In the case of physical checks, the check would bounce and be returned without payment.

Similar to other loans, the borrower pays interest on the outstanding balance of an overdraft loan. The interest on overdrafts is typically lower than the interest on credit cards, making overdrafts a better short-term option in an emergency situation. Additional fees for using overdraft protection reduce the amount available to cover your checks.

Are There Any Special Considerations?

Your bank can use its own funds to cover your overdraft. You can also link the overdraft to a credit card. If the bank uses its own funds to cover your overdraft, it typically does not affect your credit score. When a credit card is used for overdraft protection, it’s possible that you can increase your debt to a point where it could lower your credit score.

If you don’t pay your overdrafts back, your bank can turn over your account to a collection agency. This collection action can affect your credit score and get reported to the three main credit agencies. The three main credit agencies are Equifax, Experian, and TransUnion.

What Is Overdraft Protection?

Some banks pay overdrafts automatically as a courtesy to the account holder while charging fees. Overdraft protection provides the account holder with an option to prevent embarrassing shortfalls that reflect poorly on their ability to pay.

Overdraft protection works by linking your checking account to a savings account, another checking account, or a line of credit. If your account overdrafts, the other account gets tapped for funds, ensuring that you won’t have a check returned or a transaction declined. Overdraft protection also avoids triggering a non-sufficient funds charge.

How much overdraft protection is provided depends on the account and the bank. Frequently, a customer needs to request it specifically. There are many pros and cons to using overdraft protection, but keep in mind that banks provide services for a fee.

Account Holders should be sure to rely on overdraft protection only sparingly or in an emergency. If overdraft protection is used excessively, a bank can remove the protection from the account.

What Are the Pros and Cons of Overdrafting?

Pros of overdrafting include providing coverage when an account unexpectedly has insufficient funds. Embarrassment is avoided, and returned check charges from merchants or creditors won’t happen. It’s important to weigh the costs of overdrafting, however.

Overdrafting comes with a significant fee and interest. If the fees and interests are not paid off promptly, the account holder can be subjected to additional burdens. Customers who have overdraft protection may pay more in fees than those without it.

How Do Banks Generally Handle Overdrafts?

State and federal laws create obligations between the drawer of the overdraft check and the payor bank and provide remedies for collection on the check itself, on the money itself, or on the obligation for which the check was drawn. In other words, the bank may enforce the debt created by the overdraft in the same manner as any loan or promissory note may be enforced.

A bank is normally not under any obligation to permit an overdraft in the absence of agreement otherwise, even where the bank had previously permitted overdrafts by the same depositor.

Does a Bank Have the Right to Take Money from Another Account to Pay an Overdraft?

Typically, a bank has the right to apply funds from a deposit account to cover an overdraft on another deposit account if both accounts belong to the same depositor.

Can a Bank Charge an Overdraft against a Partnership?

An overdraft must, in general, be charged against the account of the depositor who wrote the overdraft check. However, problems have arisen concerning overdrafts affecting a partnership and an individual partner. A bank cannot charge an overdraft of a partnership against the individual account of a member, although the member may be liable for the overdraft.

Service Charge on Overdraft Checks

According to most state and federal law, banks are permitted to charge service charges on overdraft checks as long as the charge is “reasonable.” Reasonableness is determined by similar service charge rates in the banking industry during the overdraft.

What Is Check-Kiting and What Do Banks Do About It?

Banks sometimes fall victim to the form of fraud known as check-kiting. A check kite is a method of fraud in which the wrongdoer creates a continuous interchange of worthless checks between at least two accounts at separate banks and involves covering overdrafts with deposits of checks creating overdrafts at other banks.

A successful kite requires the existence of two conditions:

  • A time period of several days in the collection process before the depositary bank can make presentment of the checks to the drawee bank
  • The willingness of the depositary bank to paychecks drawn against uncollected funds

When a bank at which checks are presented for payment learns that its depositor, as drawer of the checks, is engaged in a kiting operation, the bank is entitled to return the checks, provided that it acts to give proper notice of dishonor and return the checks within the applicable time limits.

How Can I Avoid Check Kiting Scams?

You can avoid falling victim to check kiting scams by:

  • Never wiring money to strangers
  • Learning how to spot a fake check or check scam
  • Knowing who you are dealing with when making financial transactions

Resist any pressure to act quickly. Keep in mind that if an offer seems too good to be true, your instincts are probably right.

Banks also keep an eye out for check kiting. Banks look out for red flags such as large numbers of checks deposited each day or many checks withdrawn from the same bank account. Large amounts of cash in an account that has yet to clear or deposits made through multiple branches of the same bank are also red flags.

Should I Contact a Lawyer Regarding my Overdraft Problem?

If you have an overdraft problem, you should first look at the bank policies distributed to you when you opened your account. Suppose the overdraft issue is not covered in the policy information distributed to you or is very serious. In that case, you may wish to contact a financial lawyer to figure out what course to take with your bank and whether you should sue them for your losses.

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