Overdraft protection allows you to make a debit card payment or ATM withdrawal for more than you have in your checking account.
You will select another account or credit card to link to your checking account, and if a draft on your checking account exceeds the balance, the bank will draw from the other account to cover it. The bank will also charge you a fee. If you have overdraft coverage, the bank may cover the overdraft from its own money and charge you a higher fee.
Overdraft protection can be a useful feature, but you should understand its advantages and disadvantages before signing up.
Overdraft Protection Explained
An overdraft occurs when a transaction draws more funds from an account than the account has available. When this happens, the bank may reject the transaction. You may also face fees or other consequences from the party you are trying to pay.
Overdraft protection usually covers debit card transactions and ATM withdrawals, not paper checks or automatic debits
Banks often offer three levels of overdraft protection:
- No protection. If your transaction exceeds the amount in your balance, the transaction will be rejected.
- Overdraft protection. You link your credit card, savings account, or line of credit to your checking account and an overdraft occurs, the bank will cover it from that other account. The transaction will go through but the bank will charge you an overdraft protection fee. Overdraft protection fees are normally $10 to $12 per transaction.
- Overdraft coverage. Your bank or credit union will cover the transaction from its own money, producing a negative balance on your account. This is essentially a short-term loan. Overdraft coverage fees can be as high as $35 per transaction. If the negative balance persists for longer than a few days the bank may add an additional charge.
Overdraft protection can save you from the embarrassment and inconvenience of a rejected payment or allow you to make a necessary purchase when your account is empty, but the fees can accumulate quickly. Banks may charge additional fees if your account balance is negative for over a set period, even if you have overdraft protection
The bank cannot use overdraft protection or coverage without your consent. You must request these services. Overdraft protection may be bundled with other services in an account application and many customers who have overdraft protection or coverage don’t know they have it. Ask your bank if you’re not sure.
Remember that overdraft protection or coverage will not cover personal checks or scheduled automatic deductions from your account. If your account balance will not cover these charges you may face additional fees and the payments may not be processed.
Should You Use Overdraft Protection?
Overdraft protection is useful for some account holders and may be less essential and even risky for others. You may want to consider overdraft protection if this sounds like you:
- You live paycheck to paycheck and often keep a low balance in your checking account
- You don’t monitor your account balance closely.
- You often use your debit card for essential purchases.
These are some signs that you may not need overdraft protection.
- You typically have a substantial cushion in your checking account.
- You monitor your account balance regularly.
Remember that overdraft protection fees can add up quickly. If you accidentally draw more from the ATM than you have in your account, the bank will happily cover the difference from your other account for a fee. If you make a series of purchases thinking a deposit has cleared when it has not, each purchase can generate an overdraft protection fee.
Almost one-third of bank customers who use overdrafts report that they see the overdraft as a short-term loan to use when they are out of cash. If you use overdrafts in this way the fees may make these loans very expensive.
If you consistently use overdraft protection or coverage and often have a negative balance, your bank may close your account. It may also be more difficult to open a new account.
Beware of Using Your Credit Card for Overdraft Protection
If you’re considering using your credit card for overdraft protection, think carefully. You may be exposing yourself to serious risks:
- Your credit card issuer will usually treat an overdraft protection charge as a cash advance. Cash advances carry very high interest rates and usually have no grace period. You will pay interest on the charge from the day you make it.
- Your overdraft may push your credit utilization higher. Credit utilization is the percentage of your credit limit that you use. It’s an important factor in calculating your credit score. If your overdraft pushes your balance over 30% of your limit your credit could be affected.
- You may run up bills that you can’t pay. If your overdrafts go on your credit card and you can’t afford to pay them, you may be left making minimum payments on your card and sinking into the credit card debt trap. If you end up unable to pay your credit card bills your credit may be seriously harmed.
Your bank will not report overdrafts to credit reporting companies, so they will not affect your credit. Once your credit card is involved, however overdrafts could damage your credit record.
You May Be Able to Get Overdraft Fees Waived
Even if you don’t have overdraft protection it is sometimes possible to get overdraft fees waived. Follow these steps:
- Negotiate with your bank. If you don’t have a history of overdrafts, you may be able to get a fee waived simply by calling the customer service department and asking them to waive the fee.
- Deposit the money quickly. Many banks will waive the fee if you deposit the money to cover the overdraft on the same day or even the next morning.
- Ask about forgiveness policies. Some banks offer an annual free overdraft for customers with otherwise good records.
- Check your bank’s policy on small overdrafts. Some banks automatically waive overdraft fees for small overdrafts, usually $5 and under.
Overdraft fees are often among the highest fees a bank charges, and it pays to take the extra effort to avoid them.
Overdraft protection can be a useful way of covering accidental overdrafts or making essential purchases when your account is empty. It can also run up substantial fees very quickly, especially if you don’t keep track of your account balance or regularly use overdraft protection to cover purchases you don’t have the cash to make. If you’re considering overdraft protection, consider both the pros and the cons carefully and remember that the best way to deal with overdrafts is not to make them.
If you decide that you don’t want overdraft protection, check with your bank to be sure you don’t already have it. Whatever you decide, you can always change your mind. Overdraft protection can be added to or removed from your account at any time.