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What Is Overdraft Protection and How Does It Work

Kevin L. Matthews II

What is overdraft protection?

An overdraft occurs when you do not have enough money to cover a purchase or withdrawal in your checking account. This could result in a fee charged to the account or the purchase being declined. Overdraft protection allows you to automatically transfer enough money from another account to cover the purchase but often comes with a fee, too. We walk you through the choices when you don’t have enough to foot the bill.

How does overdraft protection work?

Overdraft protection allows you to link your checking account to another checking account, a savings account or a line of credit. When you make a purchase or withdrawal that your checking account cannot cover, it kicks in and will transfer just enough money from your linked account to cover the transaction. In most situations, you may only choose one account to protect you from overdrafting, but some banks will allow you to choose multiple accounts as a backup.

Overdraft protection fee

Depending on the bank you choose, using overdraft protection could result in a fee for each transfer while other banks don’t charge anything for using the service. You will need to carefully look at the fees your bank charges. Even for banks that do not charge an overdraft fee, you’ll need to check for any fees or penalties that may be triggered as a result of frequent transfers. For example, if your checking account is linked to your savings account, you are limited by federal regulation to six transfers per month, though in-person or ATM withdrawals don’t count against you. Make too many transfers and some banks may charge a fee for each subsequent transfer, convert your account to checking or both. Again, you will want to check with your bank.

Overdraft protection law allows consumers to opt in

Overdraft fees are a major source of income for banks —consumers pay nearly $17 billion in overdraft fees annually. Fees average about $35 per transaction, even when the customer overdrafts by a small amount. In 2010, new rules blocked banks from charging overdraft fees unless customers consent to overdraft protection or opt in. Customers may instead choose to have a purchase declined, a decision that carries no fee but perhaps incurs embarrassment. Good to know. Even if you decline overdraft protection, automatic payments — say, your utility bill — do not fall under the new rules and can still lead to an overdraft fee. Additionally, there are some situations in which your purchase can be declined by the bank and you are still charged a fee even with overdraft protection. This is common when a check “bounces,” and is known as an NSF or Non-Sufficient Funds fee.

The benefits of opting in to overdraft protection

Overdraft protection has a few benefits that can be useful to consumers beyond avoiding the embarrassment of having your card declined at dinner or in the checkout line. It may be beneficial by providing you with access to cash in case of an emergency or when you’re between paychecks though there are alternatives (more on that in a second). According to the nonprofit Consumer Education Services Inc., “An overdraft account functions almost exactly like a credit card or revolving line of credit.” One in three consumers who overdraft use the service as a way to borrow, according to The Pew Charitable Trusts. But just like a credit card, you should be cautious in how you use it and the expenses that you may be paying for the service.

The drawbacks of overdraft protection

Overdraft protection has some serious drawbacks, chief among them is that it could be an expensive service, depending on your bank. For example, even with overdraft protection, Bank of America charges $12 for each transfer due to an overdraft, Citibank charges $10. Instead of charging a fee, some banks will offer a line of credit for overdraft purposes and will charge interest on the amount overdrafted. Be mindful that using a line of credit attached to the account could affect your credit score if your bank reports it to the bureaus. Try this instead. Overdrafts can drain your savings and other accounts. Avoid frequent use by signing up for low-balance text or email alerts from your bank or keeping track of expenses with a budgeting app like Mint. If you are relying on overdrafts as a form of borrowing money, you may want to consider a personal loan instead. Bottom line: If overdraft protection encourages overspending, it may not be right for you.

Which type of accounts can be linked to a checking account for overdraft protection?

Though checking and savings accounts are the most common, you may be able to link to several different types of accounts for overdraft protection, depending on your bank. Below is a list of accounts that are commonly linked. Check with your bank to learn more about your options.
  • Checking
  • Savings
  • Home Equity Loan
  • Credit Card
  • Line of Credit

What are banks doing to ease the burden of overdraft protection fees?

Due to increased scrutiny from lawmakers and consumers, some banks have revamped their overdraft policies. Wells Fargo, for example, offers Overdraft Rewind, a service which helps you avoid overdraft fees if you receive a direct deposit before 9 a.m. local time the next day. Example: On Tuesday, your balance is $10 and an automated payment of $50 hits your account. You would be overdrawn by $40, and a $35 overdraft fee would be assessed. On Wednesday, you have a direct deposit of $200 coming into your account before 9 a.m. Wells Fargo would then waive the overdraft fee because the direct deposit covers the charge. Other banks like Chase and SunTrust Bank waive overdraft fees if the amount overdrawn is $5 or less.

How to avoid overdrawing on your account

The easiest way is to opt out of overdraft protection and have your transaction declined free. Many consumers don’t realize they have this right — or even remember opting in for the service, so check with your bank. If you decide to opt in and your bank charges overdraft fees, consider starting fresh with a bank that doesn’t.

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