Scheduling bill payments exactly on pay day - dangerous risk of overdraft?

Question

Every payday, my pay is deposited into my Citibank checking account by ACH transfer. Before pay day there is close to $0 in my checking account, as most of it is transferred to savings.

Usually in the run up to payday, I take a look at my three credit card accounts and decide how much of each credit card to pay. I then schedule electronic payments that will deduct funds from my Citibank checking account. Over the last two years I have been scheduling bill payments to deduct funds on exactly the same day I get paid.

I have recently realized that this is potentially very costly. What if the bill payment funds are deducted from my account before the pay comes in? What happens if the pay is credited at 3am, but the bill payment is processed at 2am? Because my checking account has essentially a $0 balance before payday, my account will go into overdraft -- and I will be charged $34 by my bank. Is this possible?

For concreteness, here is a version of my checking statement on a pay day a few months ago:

02/15 ACH Electronic Credit [my employer] $2000
02/15 ACH Electronic Debit [transfer to my savings] $1000
02/15 Bill Payment [credit card 1 bill payment] $400
02/15 Bill Payment [credit card 2 bill payment] $500

To me, it seems that based on the times during the night when these are processed, my acount could go into overdraft. Is this a possibility? Or, do banks act as if all the ACH transfers/bill payments for a given day are processed at the same time?

(In two years I have never had a problem, but as I add new kinds of automatic debits like transfers to external savings accounts, I'm beginning to worry I may.)

Answer 1

I got to work on overdraft class action suits with many of the largest banks in the US. Every bank we analyzed data for batch processed transactions at the end of the night, and posted credits first, then debits from high to low, with some having sub-categories for debits, ie ACH/POS/ATM/Checks where Checks often get processed first among the debits.

Your bank must describe their posting order and batch processing, but odds are it's daily batch with credits first.

You are at risk if something gets fouled up with your paycheck causing a day+ delay. There are a number of ways to avoid fees even in an overdraft situation, most conventional banks will still charge a fee for the convenience of transferring money from savings to checking to cover the overdrafts with their overdraft protection plans, but it saves you multiple overdrafts. Even better, many online banks such as Capital One 360 don't charge overdraft fees, but offer an overdraft line of credit, whereby if you were to overdraft you'd just pay interest for the amount overdrawn, it's currently a 12% APR, so being overdrawn $1000 would only cost ~$0.33/day. You may have to apply for that overdraft line of credit, and the limit may vary. They can also instantly transfer money from savings if needed at no cost. Online banks tend to have significantly better interest rates for their savings accounts as well. So some friendlier options exist if you're riding the line where overdrafts are just a delayed deposit away.

Answer 2

Even if your bank posts credits first, if they post debits by largest first, think about what that can do to you. Let's say your rent payment at the end of the day overdrafts your account by $100. And let's say that on the same day you made six small $5 - $10 purchases. Instead of one overdraft (which you might have calculated and accepted as the cost of managing your finances that day such as due to an unexpected expense), you would get one overdraft for the big transaction and then five more besides, one for each smaller debit. Yikes!

In my opinion you should be aware of these risks, and always consider the potential effects of something happening by accident.

Next, what if the company processing your employer's electronic payroll transfers has an issue and is late? What if your employer suffers a power outage, or a site incident, or even simply switches payroll providers, and the normal processes get delayed by a day or two? Or some holiday foul-up happens. Or any one of a number of things.

Personally, I get extremely nervous if I don't have at least $3,000 in my checking account, and I prefer to have quite a bit more. This has saved me multiple times when I made some boneheaded mistake, or someone else did (such as one day when the credit card representative swore up and down that the other payment I'd tried to submit was not in the system and would NOT post, but she was wrong, and two multi-thousand-dollar payments posted). The other day, the rent payment system my landlord is using double-charged me for rent. It was nasty, but I could handle it. Or let's say you're on vacation and your car breaks down. You might need that cash. Of course, a credit card protects you, but who knows what situation you'll encounter or whether your credit card won't be having some problem, itself (such as your bank thinking fraud is going on because you forgot to tell them you were traveling)?

The interest you lose by having that money out of savings and available to you will be far smaller in your lifetime than the money you save by avoiding fees, hassle, and missed opportunities.

So either change the automatic bill payments to the next day (or even 2-3 days later!), or start building up a bigger float in your account, or both. It's okay to take several months to get that float built up, but do it—you'll thank me some day.

P.S. When I'm considering options, I have several questions I use to help me weigh them better:

• What is the reward possible here, if things go well?
• What is the penalty possible here, if things go badly?
• What are the chances of getting that reward?
• What are the chances of incurring that penalty?

My first general rule is that the reward has to be likely, and significant, for me to risk something that has a medium to high penalty, and the chances of that penalty have to be reasonably low.

My second general rule is that if the penalty is extremely high, then the size of the reward has to be ridiculously stupendous, or the risk of getting the penalty has to be vanishingly small, or both.

In your case, here are my versions of the answers to these questions. You should come up with your own answers, though.

• Reward: I get to pay my bills a day or three sooner. There isn't a long period to mistakenly think my account has money in it, when I can't really afford to spend it.
• Penalty: Overdraft fees at my bank ($39?), and potentially being late on a payment to a credit card. Potentially having my bank raise my credit card interest rates and/or lower my credit card limit.
• Likelihood of reward: It's almost certain you'll get it most of the time.
• Likelihood of penalty: I wouldn't be surprised if you incurred this penalty once a year.

For me, the reward is so small that the penalty isn't worth it. I hate losing any money that I could have avoided. Is there some pressure or factor that forces you to take a risk of losing $39 in overdraft fees? Would you enjoy taking two twenty-dollar bills out of your wallet and throwing them into the street right now?

Answer 3

Before pay day there is close to $0 in my checking account, as most of it is transferred to savings

Right, so you could maintain a days buffer since you're clearly debt free, as indicated by your decision to put it into savings ... but wait:

Usually in the run up to payday, I take a look at my three credit card accounts and decide how much of each credit card to pay.

If you're not paying off AS MUCH of your credit card debt as you can, you probably shouldn't be saving. It's very likely you are paying more in credit card interest than you are earning in savings interest.

Answer 4

You'd have to check the terms of your account, but every checking account I've ever had reconciles at the end of each day, meaning so long as your deposit comes in the same day to cover the shortfall you won't get charged an overdraft.

I suppose it's possible for banks to detect intra-day overdrafts but given the variety of ways money can move in or out of your account I'd be surprised to see one that pedantic enough to deal with it.

Answer 5

I usually schedule my automatic payments a week before the due date so if something goes wrong, there's a week to recover. By the same logic, I would prefer that the deposit be in the account for at least a week before it gets spent.

I'm less worried that the bank will post debits before credits on the same day and more worried that a credit won't post at all. If the payer has an issue and the credit doesn't post or posts a day late, you still have money coming out of the account. It's a cascading failure. One missing credit combined with multiple unfunded debits.

This is not to say that this is common. I'm sure that the vast majority of deposits go through on the scheduled day. But if something goes wrong even once in a thousand times, that's once every eighty-three years. So roughly a 50% chance over a forty-two year career, on average. Using probability, it's a 40% chance that it happens at least once to any particular person.

Anyway, the week gives me a margin. I can look at my account after the deposit is supposed to post. If it doesn't, then I can panic. Or take steps to avoid problems, like rescheduling other payments. Or transferring savings to checking. Some banks will overdraft from your savings if your checking runs out. Or relaxing and letting my extra margin cover the shortfall. Figure out what went wrong and make sure that going forward, things are OK.

I personally prefer having at least a month's worth of emergency savings in my checking account. I lose out on the better interest rate but gain peace of mind. That tradeoff is of course up to you. How much is your peace of mind worth to you?

Answer 6

Anecdotally, I can offer a story that highlights the risks you are taking on by doing this. I used to live paycheck-to-paycheck, and scheduled my bills to pay on payday to keep creditors off my back. I had a checking account with [major American bank whose name shall remain anonymous to protect the guilty], which, contrary to the stated bank policy, would often post debits before credits, largest to smallest, in order to maximize overdraft fees. I was caught by this a handful of times over the years, and had to argue with the bank manager to get the fees reversed when it was clear that the bank was in error.

One fateful payday, I made many small purchases (after checking my bank balance to ensure my direct deposit went through), only to get a letter a few days later detailing over $400 in overdraft fees on about $50 in purchases, all because they batch processed the debits before the credits. To make things worse, in this instance, the bank refused to admit their error, and I was out the money (not having the resources to hire a lawyer to argue my case against the bank).

Eventually, the bank targeted with a class-action lawsuit over the practice, and though I am not a customer of theirs any more, I gather that they have been behaving better in recent years.

Maybe Citibank would never stoop so low as my bank did, but why take the risk, especially if you are in a sufficiently secure financial position to avoid it trivially?

Scheduling your bills to pay the day after payday, and your transfer to savings the day after that, gives you nearly the same result without the risk.