It’s a great feeling to pay for something, knowing you have enough money to cover the expense.
But what happens if you overextend yourself and try to spend more money than you have in your checking account?
Overdrawing your account can be an embarrassing situation, and it can lead to costly fees and negative reports to consumer credit reporting agencies.
One way to avoid overdrawing your account is to sign up for overdraft protection through your bank. Signing up for these services still can be a costly venture if you’re not careful. Here’s a closer look at overdraft protection and why it may or may not be right for you.
U.S. Bank Smartly® Checking
Offer
Earn up to $700*
Minimum Deposit Requirement
$25
Member FDIC
Earn up to $700*
$25
- Earn up to $700 when you open a new U.S. Bank Smartly® Checking account and a Standard Savings account and complete qualifying activities. Subject to certain terms and limitations. Offer valid through June 27, 2024. Member FDIC.
- Offer may not be available if you live outside of the U.S. Bank footprint or are an existing client of U.S. Bank or State Farm.
What Is Overdraft Protection?
Overdraft protection is a service offered by some banks and credit unions that allows customers to overdraw their checking accounts, generally for a fee. Having overdraft protection enables transactions to clear even when there aren’t enough funds in your account to cover the cost.
An overdraft is when transactions cause a bank account balance to fall below zero. Without overdraft protection in place, you may have checks bounce, an automatic bill payment (ACH transfer) that doesn’t clear, or debit card transactions declined. When this happens, many banks charge a non-sufficient funds (NSF) fee. There are other negative consequences for these failed transactions, like:
- Merchant fees
- Late fees
- Cancellation of accounts
- Cancellation of coverage (for insurance)
Having your debit card declined, or having a check or ACH payment bounce, can be embarrassing for individuals, but, more importantly, it leads to other financial consequences, too. Overdraft protection can help you avoid these negative situations if you’re willing to pay the fees.
How Does Overdraft Protection Work?
Customers are required to opt in for overdraft protection, either at the time of account opening or later on. Banks generally charge an overdraft fee for this service per transaction, although some online banks offer overdraft protection for free. Customers can incur multiple overdraft fees in a single day, depending on the number of transactions that occur before funds are added to the account to cover them. Some transactions, like a bounced check, may still be subject to a non-sufficient funds fee, regardless of whether overdraft protection is in place.
Types of Overdraft Protection
There’s more than one type of overdraft protection offered by banks and credit unions. Some banks charge a monthly fee for these add-on services, while others only charge fees when an overdraft occurs. What types of overdraft protection are available?
Opt-In Overdraft Protection
The standard overdraft protection offered by banks is opting in for overdraft protection. With this option, your bank pays for select overdraft transactions and charges you a fee.
Linked Bank Account
Many banks allow customers to link their checking account to another bank account, such as a savings account. Then, when an overdraft occurs, the bank transfers funds from the linked account to cover the difference. Banks typically charge a small transfer fee for this service.
Credit Card
Some banks allow customers to link a credit card to their checking accounts. When an overdraft occurs, instead of paying an overdraft fee, the amount is charged to your credit card. This service usually requires that the credit card is through the same bank as your checking account.
Keep in mind that credit card interest rates can be high. It’s best to pay off any card balance before the end of the month to avoid interest charges.
Credit Line
Another overdraft protection option some banks provide is opening an overdraft line of credit. With a credit line, banks transfer funds into a checking account to cover the overdraft. Customers pay interest on the overdrawn amount until it’s paid off. Banks that offer this service include Capital One and US Bank. One drawback to choosing to open a line of credit is that you may be subject to a hard credit check to determine eligibility, which can negatively affect your credit score.
When you open a checking account, most banks give you the option to opt in for overdraft protection. You can choose which type of protection you want, depending on what your bank offers. Some banks offer the option to automatically decline any transactions that would lead to an overdraft. Other banks provide a grace period to replace overdrawn funds before incurring an overdraft fee.
Usually there are fees associated with the protection options mentioned above, but they are typically lower than overdraft fees.
Overdraft Fees
While not all banks charge overdraft fees, many do, and they can add up quickly.
Banks charged $1.97 billion in overdraft fees in the second quarter of 2021 alone, according to data from S&P Global Market Intelligence.
According to Forbes Advisor’s 2021 checking account fees survey, the average overdraft fee charged by traditional banks is $29.50, while the average overdraft fee charged by credit unions is slightly lower at $25.81. Online banks tend to charge the lowest overdraft fee, at an average of $16.98 per overdraft.
Ways to Avoid or Eliminate Overdraft Fees
Overdraft fees are a nuisance and a drain on your finances, but they also are avoidable with some advance planning. Here are ways you can effectively avoid or eliminate overdraft fees.
Stay Informed
One of the best ways to avoid overdraft fees is to familiarize yourself with your bank’s rules and regulations concerning overdraft fees. Take time to learn what fees it charges, when they are charged and any other fine print necessary to stay informed.
Sign Up for Account Alerts
Many banks offer mobile banking access, which typically allows you to set up account notifications by email and/or text. Take advantage of this service and create alerts such as payment reminders and low balance alerts to help you avoid the need for overdraft protection.
Act Quickly if an Overdraft Occurs
If you act fast enough, some banks won’t charge any overdraft fees. Read up on your bank’s fees and how they handle overdrafts. You may be entitled to a grace period. Banks like Capital One and Wells Fargo offer customers a chance to deposit the overdraft amount—on the same business day or within one business day—before overdraft fees are charged.
Link Another Account or Credit Line to Your Checking Account
As mentioned earlier, many banks offer the option to link another bank account or credit card to a checking account to avoid overdrafts. When your account reaches a zero balance, it either transfers money from the other bank account or charges it to the credit card. Some banks offer a line of credit that also helps customers avoid overdraft fees. You may end up paying transfer fees or interest, but it’s less costly than paying individual overdraft fees.
Find a New Bank
If you aren’t happy with the way your bank handles overdrafts and overdraft fees, it might be time to find a new option. Chime, whose banking services are provided by The Bancorp Bank or Stride Bank, may allow you to overdraft up to a specific amount (such as $200) without charging an overdraft fee. If you find that you’re consistently paying overdraft fees, this may be worth pursuing.
Opt Out of Overdraft Protection Services
You always have the option to opt out of overdraft protection services at your bank or credit union. Doing so will avoid overdraft fees, but it could lead to bounced checks, declined payments or transactions and non-sufficient fund fees.
Pros and Cons of Overdraft Protection
Overdraft protections were meant as a way to help consumers and, yes, they can be quite useful. They aren’t without their share of drawbacks, though. Here’s a look at the pros and cons of overdraft protection.
Pros
- Transactions go through
- Avoid embarrassing situations
- Funds available in times of emergencies
- Avoid costly late fees and penalties
- Avoid bouncing checks
Cons
- Extra fees
- Interest charges
- Encourages overspending
- Only a temporary solution
How to Avoid Overdrafts Altogether
Avoiding overdraft fees is one way to save money, but the goal should be not to incur an overdraft fee. The real problem isn’t the overdraft fees, but rather overdrawing your checking account in general. Here are a couple of reliable ways to protect your account from overdrafts.
Keep Surplus Funds in Your Checking Account
Avoid having a low balance by keeping some extra cash in your checking account. Add more funds as needed to help ensure there’s always a buffer in your account to avoid a zero balance.
Track Your Balance and Spending
Keeping tabs on your account is one of the best ways to prevent overdrafts. The more you’re in tune with your money and your spending, the better off you’ll be. You can do this by downloading your bank’s mobile app, using accounting software or using one of the many budgeting apps now available.
Tracking your balance allows you to double-check your account before making any purchases or paying bills. Be sure to account for any transactions that haven’t cleared yet, especially as your balance gets closer to zero.
Bottom Line
While it may be possible to challenge overdraft fees after they have occurred, it’s a better—and simpler—strategy to avoid checking account overdrafts to begin with or to have an overdraft protection plan in place. You also have the option of choosing a checking account that does not charge overdraft fees, as more banks and credit unions are offering in 2021.
