What Is Overdraft Protection?
Overdraft protection is an option offered in bank accounts that prevents check, ATM, or debit card transactions, as well as wire and electronic transfers, from causing the account's balance to fall below zero and triggering an overdraft fee or a non-sufficient funds (NSF) fee. With overdraft protection, a bank will cover a shortfall and charge for the service with an overdraft fee, or “courtesy fee,” so the transaction goes through successfully.
NSF (or insufficient funds) transactions are not covered by the bank and can be expensive and disruptive. Non-preauthorized transactions made with a check and automated clearing house (ACH) withdrawals are returned unpaid, a practice known as bouncing. Most banks charge hefty overdraft and NSF fees (between $30 and $35, on average) for accounts that do not have sufficient funds. What's more, not only can the bank refuse payment and charge the account holder an NSF fee, but a penalty or fee may also be charged by the merchant for the failed transaction.
KEY TAKEAWAYS:
How Overdraft Protection Works
Customers who choose overdraft protection can link their checking accounts to credit cards, savings accounts, or other lines of credit to avoid triggering an overdraft or NSF fee. This amounts to a preapproved loan or transfer that kicks in automatically when a customer writes a check, makes a wire transfer, swipes a debit card, or asks an ATM for a sum of money in excess of an account’s balance.
Typically, an overdraft protection agreement kicks in when an account holder withdraws more than the current balance in a checking account. In that case, the individual or business with a linked account is charged a transfer fee to facilitate moving funds to cover the shortfall. The account holder may be also be charged an additional fee every month that overdraft protection is used or a fixed monthly fee for continuous protection.
Overdraft protection, sometimes called “cash reserve checking,” is most frequently used as a cushion for checking accounts, but it also can be applied to savings accounts. Banks have the right to reject loans or fund transfers if they fall outside the rules of the overdraft protection agreement.
Important: If you bounce a check you can incur a variety of charges or, in extreme cases, see your bank close your account, hurting your chance of opening a new checking account.
In the absence of overdraft protection, it is not uncommon for banks to charge multiple overdraft or NSF fees per day, such as when a consumer makes successive purchases without realizing that the amount in their account is insufficient to pay for the purchases. Many banks also charge an extended overdraft fee if a checking account goes negative for more than a few days. It’s important to note that even if you have overdraft protection, banks will still charge this additional fee.
Example of Overdraft Protection
A renter with overdraft protection and a linked account writes an $800 check to cover the monthly rent on an account that only has $650 in it. Instead of bouncing the check due to insufficient funds, the renter’s overdraft protection kicks in when the check is cashed.
The bank charges a transfer fee of $15 for approving a debit transaction that exceeds available funds. The renter will now have a balance of $635 ($650 - $15) and has to pay off $800 through a linked credit card, line of credit, or savings account.
Important: Bank customers can opt in or out of overdraft protection for their checking or savings accounts.
Special Considerations
Overdraft protection lines of credit can range from $250 to $5,000 and above and, of course, come with an interest rate. If a credit card is used, it should be noted that the amount is treated as a cash advance. This has no grace period and usually incurs a high interest rate, as well as a cash advance fee (usually a $10 flat fee or 5% of the advance, whichever is greater), making it a fairly expensive form of overdraft protection. A linked savings account is probably the least expensive solution, but it must hold enough money to cover the needed funds.
Overdraft Protection Trends
In 2019 the most common overdraft fee was $35, with an average of $33.36, according to a BankRate.com survey of 10 banks and thrifts in 25 large U.S. markets. Credit unions tend to charge less, an average of $26, according to a 2019 NerdWallet.com study. Some banks, such as online banks, do not charge overdraft fees.
Many consider overdraft fees abusive, but little has been done about them because, as of mid-2018, CFPB Acting Director Mick Mulvaney halted rule-making plans to reform them. However, in May 2019, the CFPB announced a plan to review the overdraft rule.2 That review appears to be incomplete as of February 2020.
Overdraft Protection: Pros and Cons
Is it really protection worth having?
Checks and other debit transactions clear when you sign up for overdraft protection, even if your account lacks sufficient funds. In exchange for this service, your bank may charge hefty overdraft fees. Is this protection worth having? Here is a look at the pros and cons.
Pros and Cons of Overdraft Protection
When you sign up for overdraft protection, your bank will use a linked backup source that you designate a savings account, credit card, or line of credit to pay for transactions whenever the checking account lacks the needed funds.
Pro: Your transaction will happen
Even if you don’t have enough money in your checking account, the check will clear, the ATM will give you cash, or the debit card transaction will go through. No more bounced checks, with the inconvenience and embarrassment that can come with them.
Con: You will pay fees and interest
One downside is that the bank will charge an overdraft transfer fee even if your own money is covering the shortfall. In the case of an overdraft line of credit, you’ll pay interest on the amount you borrow until you pay it back. Consumers who opt in to overdraft protection pay more in overdraft fees than those who choose not to, according to the Consumer Financial Protection Bureau (CFPB).
Con: Transactions may not clear if your backup source is low or empty
Another disadvantage: Your transactions still won’t clear if you don’t have enough money in the linked account to cover the shortfall. It might not be a big deal to have a transaction declined, but in an emergency it’s nice to have a source of backup funds. However, if your backup funding source is tapped out as well, you still won’t be able to complete the transaction.
What’s more, if you know you can’t rely on overdraft protection in an emergency, you have to carry extra cash or a credit card, just in case. Paying cash for emergencies is your least expensive option. Using a credit card could be more or less expensive than overdraft protection, depending on the agreement and conditions.
Important: The simplest and least expensive way of having overdraft protection is to link your checking account to your savings account, thus covering your overdraft with your own funds.
What Happens When You Don't Have Overdraft Protection
Without overdraft protection, your bank can still charge a non-sufficient funds (NSF) fee that can be comparable to an overdraft fee if there isn’t enough money in your account to cover the debit. In addition, the party receiving the bad check can demand reimbursement for the returned check fee and report you to ChexSystems, which is like a credit report for your banking history.
As of September 2019, the typical overdraft fee was $35 per item, according to a NerdWallet.com study. These fees can add up quickly if you make several transactions before you realize your account is in the red. If you are making a small purchase or if you have another source of funds don’t write a check or use your debit card if you’re even a little unsure whether your funds will cover the purchase.
Terms and conditions for overdraft fees vary significantly from one bank to another. If your bank’s overdraft fees are high, you may find it less expensive to pay using a credit card. This is different from linking your overdraft protection directly to a credit card, which can be pricey, because the credit card treats the linked transaction as a cash advance with a high interest rate and no grace period.
Other Ways to Avoid Overdraft Fees
While it may be worth opting in if you don’t want transactions to be declined, a better choice is to sign up for email or text alerts to flag low checking account balances, so you can avoid overdraft fees altogether. These alerts will give you an opportunity to add funds to your checking account, wait to make a purchase, or use an alternate form of payment.
You can also avoid overdraft charges with some banks’ free overdraft transfer services, which will automatically transfer money in preset increments (such as $100) from a linked savings account into your checking account when the balance is low.
(c) investopedia.com
Overdraft protection is an option offered in bank accounts that prevents check, ATM, or debit card transactions, as well as wire and electronic transfers, from causing the account's balance to fall below zero and triggering an overdraft fee or a non-sufficient funds (NSF) fee. With overdraft protection, a bank will cover a shortfall and charge for the service with an overdraft fee, or “courtesy fee,” so the transaction goes through successfully.
NSF (or insufficient funds) transactions are not covered by the bank and can be expensive and disruptive. Non-preauthorized transactions made with a check and automated clearing house (ACH) withdrawals are returned unpaid, a practice known as bouncing. Most banks charge hefty overdraft and NSF fees (between $30 and $35, on average) for accounts that do not have sufficient funds. What's more, not only can the bank refuse payment and charge the account holder an NSF fee, but a penalty or fee may also be charged by the merchant for the failed transaction.
KEY TAKEAWAYS:
- Overdraft protection is a guarantee that a check, ATM, wire transfer, or debit card transaction will clear if the account balance falls below zero.
- There may be heavy fees and interest associated with overdraft protection, depending on the kind of linked account used.
- Overdraft protection lines of credit can range from $250 to $5,000 and above.
How Overdraft Protection Works
Customers who choose overdraft protection can link their checking accounts to credit cards, savings accounts, or other lines of credit to avoid triggering an overdraft or NSF fee. This amounts to a preapproved loan or transfer that kicks in automatically when a customer writes a check, makes a wire transfer, swipes a debit card, or asks an ATM for a sum of money in excess of an account’s balance.
Typically, an overdraft protection agreement kicks in when an account holder withdraws more than the current balance in a checking account. In that case, the individual or business with a linked account is charged a transfer fee to facilitate moving funds to cover the shortfall. The account holder may be also be charged an additional fee every month that overdraft protection is used or a fixed monthly fee for continuous protection.
Overdraft protection, sometimes called “cash reserve checking,” is most frequently used as a cushion for checking accounts, but it also can be applied to savings accounts. Banks have the right to reject loans or fund transfers if they fall outside the rules of the overdraft protection agreement.
Important: If you bounce a check you can incur a variety of charges or, in extreme cases, see your bank close your account, hurting your chance of opening a new checking account.
In the absence of overdraft protection, it is not uncommon for banks to charge multiple overdraft or NSF fees per day, such as when a consumer makes successive purchases without realizing that the amount in their account is insufficient to pay for the purchases. Many banks also charge an extended overdraft fee if a checking account goes negative for more than a few days. It’s important to note that even if you have overdraft protection, banks will still charge this additional fee.
Example of Overdraft Protection
A renter with overdraft protection and a linked account writes an $800 check to cover the monthly rent on an account that only has $650 in it. Instead of bouncing the check due to insufficient funds, the renter’s overdraft protection kicks in when the check is cashed.
The bank charges a transfer fee of $15 for approving a debit transaction that exceeds available funds. The renter will now have a balance of $635 ($650 - $15) and has to pay off $800 through a linked credit card, line of credit, or savings account.
Important: Bank customers can opt in or out of overdraft protection for their checking or savings accounts.
Special Considerations
Overdraft protection lines of credit can range from $250 to $5,000 and above and, of course, come with an interest rate. If a credit card is used, it should be noted that the amount is treated as a cash advance. This has no grace period and usually incurs a high interest rate, as well as a cash advance fee (usually a $10 flat fee or 5% of the advance, whichever is greater), making it a fairly expensive form of overdraft protection. A linked savings account is probably the least expensive solution, but it must hold enough money to cover the needed funds.
Overdraft Protection Trends
In 2019 the most common overdraft fee was $35, with an average of $33.36, according to a BankRate.com survey of 10 banks and thrifts in 25 large U.S. markets. Credit unions tend to charge less, an average of $26, according to a 2019 NerdWallet.com study. Some banks, such as online banks, do not charge overdraft fees.
Many consider overdraft fees abusive, but little has been done about them because, as of mid-2018, CFPB Acting Director Mick Mulvaney halted rule-making plans to reform them. However, in May 2019, the CFPB announced a plan to review the overdraft rule.2 That review appears to be incomplete as of February 2020.
Overdraft Protection: Pros and Cons
Is it really protection worth having?
Checks and other debit transactions clear when you sign up for overdraft protection, even if your account lacks sufficient funds. In exchange for this service, your bank may charge hefty overdraft fees. Is this protection worth having? Here is a look at the pros and cons.
- With overdraft protection, if you don’t have enough money in your checking account, checks will clear and ATM and debit card transactions will still go through.
- If you don’t have enough overdraft protection to cover a shortfall, transactions won’t go through, and fees may be high.
- Be sure to read the fine print before signing up for overdraft protection, as fees and terms vary from one bank to another.
Pros and Cons of Overdraft Protection
When you sign up for overdraft protection, your bank will use a linked backup source that you designate a savings account, credit card, or line of credit to pay for transactions whenever the checking account lacks the needed funds.
Pro: Your transaction will happen
Even if you don’t have enough money in your checking account, the check will clear, the ATM will give you cash, or the debit card transaction will go through. No more bounced checks, with the inconvenience and embarrassment that can come with them.
Con: You will pay fees and interest
One downside is that the bank will charge an overdraft transfer fee even if your own money is covering the shortfall. In the case of an overdraft line of credit, you’ll pay interest on the amount you borrow until you pay it back. Consumers who opt in to overdraft protection pay more in overdraft fees than those who choose not to, according to the Consumer Financial Protection Bureau (CFPB).
Con: Transactions may not clear if your backup source is low or empty
Another disadvantage: Your transactions still won’t clear if you don’t have enough money in the linked account to cover the shortfall. It might not be a big deal to have a transaction declined, but in an emergency it’s nice to have a source of backup funds. However, if your backup funding source is tapped out as well, you still won’t be able to complete the transaction.
What’s more, if you know you can’t rely on overdraft protection in an emergency, you have to carry extra cash or a credit card, just in case. Paying cash for emergencies is your least expensive option. Using a credit card could be more or less expensive than overdraft protection, depending on the agreement and conditions.
Important: The simplest and least expensive way of having overdraft protection is to link your checking account to your savings account, thus covering your overdraft with your own funds.
What Happens When You Don't Have Overdraft Protection
Without overdraft protection, your bank can still charge a non-sufficient funds (NSF) fee that can be comparable to an overdraft fee if there isn’t enough money in your account to cover the debit. In addition, the party receiving the bad check can demand reimbursement for the returned check fee and report you to ChexSystems, which is like a credit report for your banking history.
As of September 2019, the typical overdraft fee was $35 per item, according to a NerdWallet.com study. These fees can add up quickly if you make several transactions before you realize your account is in the red. If you are making a small purchase or if you have another source of funds don’t write a check or use your debit card if you’re even a little unsure whether your funds will cover the purchase.
Terms and conditions for overdraft fees vary significantly from one bank to another. If your bank’s overdraft fees are high, you may find it less expensive to pay using a credit card. This is different from linking your overdraft protection directly to a credit card, which can be pricey, because the credit card treats the linked transaction as a cash advance with a high interest rate and no grace period.
Other Ways to Avoid Overdraft Fees
While it may be worth opting in if you don’t want transactions to be declined, a better choice is to sign up for email or text alerts to flag low checking account balances, so you can avoid overdraft fees altogether. These alerts will give you an opportunity to add funds to your checking account, wait to make a purchase, or use an alternate form of payment.
You can also avoid overdraft charges with some banks’ free overdraft transfer services, which will automatically transfer money in preset increments (such as $100) from a linked savings account into your checking account when the balance is low.
(c) investopedia.com
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