What Is Overdraft Protection?
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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.
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:
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.
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Overdraft protection has a few drawbacks (other than cost) that you should be aware of.
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.
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.
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.
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.
Related: Banks with No Overdraft Fees
Even better, avoid overdrafts altogether. Here are some tips:
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.
Don't get caught paying nuisance checking account fees. Check out Motley Fool Money's top checking account picks to open a fee-free checking account that earns a high interest rate.
Maybe not. It might encourage overspending and could put you into debt. But it's worth considering because you get peace of mind knowing you're unlikely to be declined at the cash register. And some banks offer overdraft protection without charging you anything.
Be careful of linking checking accounts to savings accounts for overdraft protection. You may be charged for withdrawing money from a savings account more than six times monthly. This applies even when your bank's overdraft protection is fee free.
We're firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. Motley Fool Money does not cover all offers on the market. Motley Fool Money is 100% owned and operated by The Motley Fool. Our knowledgeable team of personal finance editors and analysts are employed by The Motley Fool and held to the same set of publishing standards and editorial integrity while maintaining professional separation from the analysts and editors on other Motley Fool brands. Terms may apply to offers listed on this page. APYs are subject to change at any time without notice.
