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After Navigation
Home Money Management Debt Management What is Overdraft Protection
  • Contents
  • What Is Overdraft Coverage?
  • The Benefits of Overdraft Protection
  • The Pitfalls of Overdraft Protection
  • Alternatives to Overdraft Protection

What is Overdraft Protection

Penny Redlin
By Penny Redlin
October 5, 2022
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When you spend more money than what you have in your bank account, an overdraft can occur. When this happens, your financial institution may charge you an insufficient funds fee. What this means is that your bank chooses to cover the transaction, but at a price. Unfortunately, that price is usually high.

Overdraft fees are some of the most common and costly fees that checking accounts incur. With some as much as $35 per debit card transaction, these fees can quickly add up. This is especially true given that many banks allow multiple overdrafts on a single account in a single day. If you overdraft twice, the balance in your account becomes -$70.00, plus the cost of the item you attempted to purchase. If you overdraft three times, you’re up to $105 in overdraft charges.

The bottom line is that overdrafts can be expensive. The good news is that many banks are either doing away with these fees or offering overdraft coverage.

What Is Overdraft Coverage?

If you operate without overdraft protection (a service that prevents the rejection of a transaction if you don’t have enough money in your account to cover it), you may pay a high price each time your account is overdrawn. This is because, when you spend more than you have available, your bank can choose to cover the balance of the transaction in the amount that your account was short. To compensate for this “loan,” it charges an overdraft fee. Though this fee varies from financial institution to financial institution, it can run between $30 and $35 per transaction.

Some banks may choose to decline the transaction but charge an NSF regardless. When this happens, not only can you face steep overdraft penalties but also, a merchant or provider may refuse your transaction. If you attempt to cash a check with insufficient funds in your account, you could be guilty of check fraud. Though single instances of bounced checks rarely result in legal charges, merchants can, and often do, penalize customers for failed transactions.

You can avoid overdrafts, and the associated fees and embarrassment, by investing in overdraft protection services. When you opt-in for overdraft coverage, you will link a savings account, a line of credit or another source of funding to your checking account. When you withdraw more than your available balance, such as via merchant or ATM transactions, your linked savings account will kick in to cover overdrafts. So long as you have sufficient funds in that account, your transaction will go through as normal, and without triggering bank charges or declined transaction fees.

It’s important to note that though most financial institutions offer overdraft protection services for free, many do charge a transfer fee. At between $10 to $12.50 per transfer, this fee is much smaller than the standard overdraft charge. However, some banks also charge a fixed monthly fee for continual protection in addition to the transfer fee.

The Benefits of Overdraft Protection

  • Overdraft protection can prove highly useful in many instances, especially if you find your account continually running low on funds. Some key benefits of overdraft protection are as follows:
    You can still purchase your goods and services despite not having enough money in your go-to checking account to cover the costs.
  • Many banks offer overdraft protection services for free. If your bank does charge a fee, it’s likely to be minimal.
  • The transfer fee associated with overdraft coverage is typically less than half the standard overdraft fee.
  • Overdraft coverage can help you avoid fees associated with returned checks or transactions.
  • Overdraft coverage makes it easy to access funds from other accounts in a pinch.

In many ways, overdraft protection can save you from the embarrassment of receiving a declined notice at checkout as well.

The Pitfalls of Overdraft Protection

Though there may seem little wrong with linking an account to cover potential overdrafts, overdraft coverage does come with a few drawbacks. The greatest pitfall is that it encourages overspending. If you already struggle with money management, overdraft services merely serve to perpetuate your bad habits. Not only are you draining your standard checking account but also, you’re possibly dipping into savings or emergency funds.

There are other pitfalls of using overdraft protection. A few top complaints are as follows:

  • You may have to pay a monthly fee for the service in addition to transfer fees.
  • Financial institutions typically charge a transfer fee per transaction, which means you may incur multiple fees per day.
  • There is still the risk of having your bank decline your transaction if your linked account also has insufficient funds.
  • If your bank lets you go into the negative without penalizing you, you will have to repay that amount.

If you rarely overdraft, and if you think you can utilize the services responsibly, overdraft protection may be right for you. However, if you regularly withdraw from your checking account, and if you suspect you will take advantage of overdraft services, you may want to consider other money management options.

Alternatives to Overdraft Protection

Though overdraft coverage affords consumers significant convenience, it’s not for everyone. Whether you don’t trust yourself to not abuse overdraft protection, or you simply want to find better ways to manage your money, consider alternative safeguards.

Don’t Spend Beyond Your Means

The number one way to avoid overdrawing your checking account is to avoid doing it in the first place. Create a budget that accounts for both your fixed and non-fixed expenses. If, at the end of every month, you find you’re tight on funds, go through your discretionary expenses to see where you can make cuts. Committing to spending less in these areas can help you stay in the black.

Look Into Next Day Grace

Some banks, offer grace periods to account holders who overdraft. If your bank is one of them, you have until the end of the next business day to make your account positive. Only if you fail to do so within the grace period will your bank charge you an overdraft fee.

Investigate Fee-Free Checking

Some banks forego grace periods and auto decline in exchange for leniency. Credit unions and online banks often offer consumer-friendly programs that do away with all fees, including overdraft fees. If you have an account with one of these banks, you can overdraw up to a certain amount without risking a penalty.

Overdraft protection is a convenient and valuable tool, but it has the potential for abuse. If you continually overdraft, consider taking more drastic measures to remedy your financial situation, such as finding a better-paying job or some other means to increase your income.

 

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Edvisors (“Edvisors Network, Inc.”) provides independent advertising-supported platforms for consumers to search compare and apply for private student loans. Loan offers from participating lenders that appear on our websites are not affiliated with any college and/or universities, and there are no colleges and/or universities which endorse Edvisors’ products or services. Lender search results do not constitute an official college preferred lender list. Edvisors receives compensation from lenders that appear on this site. This compensation may impact the placement of where lenders appear on this site, for example, the order in which the lenders appear when included in a list. Not all lenders participate in our sites and lenders that do participate may not offer loans to every school.

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