Proposal to limit late and overdraft fees: How to avoid them in the 1st place

In a bid to slash what he calls "junk fees," President Joe Biden announced several initiatives this week to combat fees that he sees as costly and unfair to consumers. This includes working to limit late fees on credit card payments and is in addition to remarks he made on curbing overdraft fees back in October.

This comes after the creation of the White House Competition Council in 2021, tasked with finding unfairly high or surprise fees that consumers must pay for basic services — something the president believes government agencies should protect consumers against. The government estimates that these initiatives could save American families $12 billion annually, assuming these initiatives are implemented as laws.

But what are these fees? And is there a way to avoid them altogether?

Here's a closer look at late fees, overdraft fees and how you can avoid paying them.

Related: President Biden targeting fees in big consumer push on travel and credit cards

What are late fees?

Late fees are fees that you pay when you don't make your minimum credit card payment on time. When is the cutoff time before you're late? That varies by bank.

Some credit card issuers require you to pay by 5 p.m. Eastern time (the end of their business day). Others allow you to pay until midnight on the due date. Thus, it's important to know your credit card issuer's policy. Paying after this time can lead to fees as high as $41 for each late payment.

However, if you make your minimum payment by the cutoff time, you won't pay a late fee. Remember that making only the minimum payment will lead to interest on your credit card bill.

Related: The best way to pay your credit card bills

On Wednesday, the Consumer Financial Protection Bureau proposed a rule to ban "excessive" fees that credit card issuers charge for late payments. CFPB Director Rohit Chopra said that these fees greatly exceed any costs that lenders incur from late payments.

In 2009, "Congress banned excessive credit card late fees, but companies have exploited a regulatory loophole that has allowed them to escape scrutiny for charging an otherwise illegal junk fee,” Chopra said. The CFPB said this new rule would cap late fees at $8 or 25% of the minimum payment due — significantly lower than the average of $31 the agency currently sees with these fees. However, late fees can be as high as $41.

Related: How to save your credit score after a late payment

The CFPB estimates that reducing late fees from $31 to $8 would save consumers $9 billion annually — three-quarters of the $12 billion in late fees consumers pay.

"Junk fees have unfortunately become the norm," said Chopra, claiming credit card issuers use these excessive fees as an additional source of profit. Chopra says the new $8 cap is still five times higher than the actual cost of recovering late payments — negating the idea that financial institutions would operate at a negative cost under these new regulations.

The new rule could take effect in 2024 after a comment period, according to Chopra. It's worth noting, however, that proposed regulations usually are subject to challenges, litigation by industry groups, delays and modifications on their way to becoming law.

Related: 3 mistakes people make when they get their 1st credit card

How to avoid late fees

Making the minimum required payment by your bank's cutoff time means you won't pay a late fee. Again, check with your bank to see what time it uses to determine when payments are late on the due date.

Paying the minimum amount due will avoid late fees. It also avoids other penalties, such as raised interest rates or annual percentage rates.

However, paying only the minimum amount due can lead to other expenses, such as interest on your credit card balance. The best way to avoid paying interest on credit cards is to pay your full balance each month.

Related: TPG's 10 commandments of credit card rewards

If you're likely to forget your bill due dates, setting up autopay on your credit cards can help you avoid missed or late payments.

What are overdraft fees?

While late fees are assessed on credit cards, overdraft fees are related to your checking account. These fees are assessed when your account goes negative. How can that happen?

Overdraft fees come from either overspending on your account or spending money from your account before it is available. The latter can happen when deposits (such as a large check) are put on hold temporarily, but you make withdrawals in the meantime thinking that money is already available.

Thus, your account balance goes below zero in these instances, which is an "overdraft." Banks typically assess fees for this — $35 per instance, on average. These are similar to the fees related to "bounced checks" — when you write a check that is rejected due to insufficient funds in your account.

The CFPB targeted fees for bounced checks in 2021, and many banks agreed to end these fees (PDF document).

However, you may be surprised to see an overdraft fee even when your bank account balance shows you have sufficient money for a purchase. The CFPB is targeting these fees, saying banks use complex and potentially illegal methods to assess fees based on the order in which they process transactions — something consumers don't have access to or clearly understand.

The agency estimates that eliminating these fees will save consumers more than $1 billion annually.

How to avoid overdraft fees

Ensuring you always have a positive balance in your bank account and not making check or debit card payments that are higher than your current balance sounds simple. However, there are several factors involved.

First, be careful with holds placed on your deposits. If your bank won't make a deposit available for five days, that means you cannot use that money for bill payments or withdrawals until it's available. Spending against unavailable deposits will cause an overdraft.

Additionally, holds placed on your debit card can cause overdrafts. For example, if a hotel places a hold for incidentals on your debit card, the funds may not be released to your account (becoming available to you) for several days after you check out. Until that money becomes available, you can't spend or withdraw it. Your usable account balance may be lower than you think it is when there are holds on your debit card.

Related: 5 things you need to know about debit and credit card holds

Thus, it's important to understand exactly how much money is available in your checking account when you make a purchase or withdraw cash. You also need to understand the timeline your bank uses to determine when your deposits become available, since that may not be instant.

Related: 4 reasons why you shouldn't use your debit card

Bottom line

Consumers don't like paying excessive fees. Fees also place additional burdens on those struggling to make payments on time. If your checking account balance is negative, that means there isn't any money in your account. That problem is only exacerbated when an additional fee is tacked on — putting your balance further into the red.

The federal government has proposed action against overdraft fees and late-payment fees, claiming these will save significant sums for consumers each year.

However, there are methods you can employ to avoid these fees. Paying your bills on time, closely monitoring your account balances and understanding holds placed on your account can help you avoid these fees altogether. Spending within your means (to avoid overdrafts and interest on credit cards) may be the most important tip of all.

The fees discussed in this article may be more common for those struggling to manage debt. If that's you, here are some resources that may help:

• How to consolidate and pay off credit card debt
• Here are 3 reliable ways to pay off credit card debt
• 6 simple rules to stay out of credit card debt
• Why Dave Ramsey is wrong about credit cards
• 6 things to do to improve your credit score this year
• Know your rights: 3 tips for dealing with debt collectors
• 8 basic financial services and credit card concepts you should know