What Is Overdraft Protection?

Attempting to spend more money than you have in your checking account is called an overdraft. Normally, your bank or credit union declines the transaction, and it may charge a non-sufficient funds (NSF) fee. But if you'd rather the transaction went through, you can opt into overdraft protection. Here's a closer look at what that is and how it works.

What is overdraft protection?

Overdraft protection helps you pay for things you don't have the cash for, but it can be costly. Banks used to auto-enroll customers in overdraft coverage, but the government now requires you to opt into this service.

There's a few ways your bank might offer overdraft protection. Here's what happens when you overdraw your protected checking account:

• Linked savings account: Your bank will automatically cover the difference with money in your savings account. You may be charged a small fee per overdraft.
• Linked credit card: Your bank will do a cash advance on a linked credit card. The bank may charge a fee and it may only let you link to one of its branded credit cards. This option may be limited to users with good credit scores.
• Per-transaction coverage: Your bank will cover the transaction out of pocket. Until you fund the account, it will charge you each time you purchase something.
• Line of credit: Your bank will loan you the money needed to cover overdraft purchases. Your balance may begin accruing interest immediately. This option may be limited to users with good credit scores.

All of these methods come at a cost and you could pay a fee for every single overdraft. The fees can stack quickly, especially if you make several purchases before realizing you've overdrawn your account. Some banks will offer grace periods before charging you fees. A handful of banks offer overdraft protection for free.

Below are other limitations to overdraft protection.

Limits on overdraft protection

Overdraft protection has a few drawbacks (other than cost) that you should be aware of.

How much overdraft protection covers

If you have a linked savings account, you could still wind up with an NSF fee and a declined transaction if you don't have enough money in your savings account to cover the overdraft. The same is true for linked credit cards or lines of credit when you attempt to exceed your credit limits. Stay within your credit limits.

How many times you overdraw your account

Some banks limit the number of overdraft fees they'll charge you daily or monthly, but many impose no such safeguards. Ask your bank if you're unsure how it handles this.

If you have a linked savings account and overdraw your account repeatedly, you could face penalties for making more than six savings account withdrawals per month. Ask your bank if you're unsure of your savings account withdrawal limits.

How long your account stays overdrawn

If your account remains overdrawn for several weeks, your bank may charge you an extended overdraft fee on top of the initial overdraft fees.

It could also report you to a collections agency and ChexSystems, the reporting agency that tracks how responsibly you've managed your bank accounts in the past. This could damage your banking reputation, making it harder to open another bank account.

Overdraft fees

Your overdraft fees depend on your bank and method of overdraft protection. You may only pay $10 to $12 per overdraft for linking a savings account, credit card, or line of credit. You could pay $35 or more if your bank charges you a per-transaction fee. Overdraft lines of credit and linked credit card balances will also accrue interest. In contrast, the NSF fee you pay if you overdraft without protection is typically around $35.

How much you're charged also depends on how your bank orders your transactions. Some use the chronological approach, which records your purchases in the order you made them, while others order your daily purchases from largest to smallest.

Example: If you have $200 in your checking account, and you use your debit card to make a $5, a $10, a $25, and a $200 purchase before you realize you've overdrawn your account. If your bank orders payments chronologically, you'd only pay one overdraft fee. But if your bank orders your purchases from largest to smallest, you'd pay three separate fees.

Is overdraft protection worth it?

Overdraft protection helps you cover purchases, but it can get costly fast. If you're considering opting in, know your bank's overdraft protection options and any associated fees. Make sure you're comfortable with them.

Even better, avoid overdrafts altogether. Here are some tips:

• Monitor your spending. Use a budgeting app or periodically review your transaction history and avoid spending when your balance is low.
• Sign up for balance alerts. Many banks will send you a text, email, or app notification when your balance drops below a certain point.
• Review your account balances. Before you make a purchase, check your checking account balance to make sure you have enough money.

Overdraft protection isn't inherently good or evil. It's a tool that smart spenders might find useful; if you're occasionally charged $35 NSF fees, opting in could save you money. However, it also encourages unhealthy spending habits. Understand the risks before signing up. When in doubt, skip overdraft protection and just keep an eye on your balances.

Some banks will decline overdraw attempts without charging you. If you're frequently charged overdraft fees, you may want to consider switching banks. These days, you should not be getting charged for spending money in your checking account.

Still have questions?

Here are some other questions we've answered:

• How much should I keep in my checking account?
• How can I avoid checking account fees?
• How do I open a checking account online?