It’s a great feeling to pay for something knowing that you have enough money to cover the expenses.
But what if you go above and beyond and try to spend more money than you have in your checking account?
Going over your account can be an embarrassing situation, and it can result in expensive fees and negative reports to consumer credit bureaus.
One way to avoid overdrafting is to purchase overdraft protection from your bank. Signing up for these services can always be an expensive endeavor if you’re not careful. Here’s an overview of overdraft protection and why it may or may not be right for you.
What is overdraft protection?
Overdraft protection is a service offered by some banks that allows customers to verify accounts, usually for a fee. Overdraft protection helps clear transactions even if there is not enough funds in your account to cover the cost.
An overdraft occurs when transactions drop a bank account balance below zero. Without overdraft protection in place, you may have bounced checks, automatic bill payment (ACH transfer) that goes unchecked, or declined debit card transactions. When this happens, many banks charge an insufficient funds fee (NSF). There are other negative consequences for these failed transactions, such as:
- Merchant fees
- Late fee
- Cancellation of accounts
- Cancellation of coverage (for insurance)
Refusing your debit card or rejecting an ACH check or payment can be embarrassing for individuals, but more importantly, it has other financial consequences. Overdraft protection can help you avoid these negative situations if you’re willing to pay the fees.
How does overdraft protection work?
Customers should opt for overdraft protection, either when opening the account or later. Banks typically charge an overdraft fee for this service per transaction, although some online banks offer free overdraft protection. Customers may incur multiple overdraft fees in a single day, depending on the number of transactions that occur before funds are added to the account to cover them. Some transactions, such as a bad check, may still be subject to insufficient funds charges, whether or not overdraft protection is in place.
Types of overdraft protection
There are several types of overdraft protection offered by banks and credit unions. Some banks charge a monthly fee for these additional services, while others only charge a fee for overdraft. What types of overdraft protection are available?
Opt-in overdraft protection
The standard overdraft protection offered by banks opts for overdraft protection. With this option, your bank pays for certain overdraft transactions and charges you a fee.
Linked bank account
Many banks allow customers to link their checking account to another bank account, such as a savings account. Then, in the event of an overdraft, the bank transfers funds from the linked account to cover the difference. Banks usually charge a nominal transfer fee for this service.
Some banks allow customers to link a credit card to their checking account. When an overdraft occurs, instead of paying an overdraft fee, the amount is charged to your credit card. This service generally requires the credit card to go through the same bank as your checking account.
Keep in mind that credit card interest rates can be high. It is best to pay off the card balance before the end of the month to avoid interest charges.
Some banks offer another overdraft protection option: opening a line of credit for overdraft. With a line of credit, banks transfer funds to a checking account to cover the overdraft. Customers pay interest on the overdraft amount until it is repaid. Banks that offer this service include Capital One and US Bank. One downside to choosing to open a line of credit is that you may be subjected to a rigorous credit check to determine your eligibility, which can negatively impact your credit score.
When you open a checking account, most banks offer you the option of purchasing overdraft protection. You can choose the type of protection you want, depending on what your bank offers. Some banks offer the option of automatically refusing any transaction that would result in an overdraft. Other banks provide a grace period to replace overdrawn funds before incurring overdraft fees.
Usually there are fees associated with the protection options mentioned above, but they are usually lower than the overdraft fee.
While not all banks charge an overdraft fee, many do and can add up quickly.
According to a 2019 survey by research firm Moebs Services, the median overdraft fees charged by banks were $ 32 in 2019. The median overdraft fees charged by credit unions in 2019 were just under $ 30. Overdraft fees, according to the survey, accounted for $ 33.8 billion in revenue in 2019.
Ways to Avoid or Eliminate Overdraft Fees
Overdraft fees are a nuisance and a drain on your finances, but they are also preventable with some advance planning. Here are ways to effectively avoid or eliminate overdraft fees.
One of the best ways to avoid overdraft fees is to familiarize yourself with your bank’s rules and regulations regarding overdraft fees. Take the time to find out what fees it charges, when they’re charged, and other fine print needed to stay informed.
Sign up for account alerts
Many banks offer access to mobile banking services, which typically allows you to set up account notifications by email and / or SMS. Take advantage of this service and create alerts like payment reminders and low balance alerts to help you avoid the need for overdraft protection.
Act quickly in the event of an overdraft
If you act fast enough, some banks won’t charge any overdraft fees. Find out about your bank’s fees and how they handle overdrafts. You may be entitled to a grace period. Banks like Capital One and Wells Fargo offer customers the option of depositing the overdraft amount – on the same business day or within one business day – before overdraft fees are charged.
Link another account or line of credit to your checking account
As mentioned earlier, many banks offer the option of linking another bank account or another credit card to a checking account to avoid overdrafts. When your account reaches zero balance, it either transfers money from the other bank account or charges it to the credit card. Some banks offer a line of credit which also helps customers avoid overdraft fees. You might end up paying a transfer fee or interest, but it’s cheaper than paying individual overdraft fees.
Find a new bank
If you’re not happy with the way your bank is handling overdrafts and overdraft fees, it might be time to find a new bank. There are banking services, like Carillon, this may allow you to overdraft up to a specific amount (such as $ 100) without charging an overdraft fee. If you find that you regularly pay overdraft fees, it may be worth pursuing.
Disable overdraft protection services
You can always opt out of your bank or credit union’s overdraft protection services. This will avoid an overdraft fee, but it could result in bad checks, declined payments or transactions, and insufficient funds charges.
Advantages and disadvantages of overdraft protection
The overdraft protections were meant to help consumers and, yes, they can be very useful. However, they are not without their share of drawbacks. Here’s an overview of the pros and cons of overdraft protection.
- Transactions go through
- Avoid embarrassing situations
- Funds available in case of emergency
- Avoid costly late fees and penalties
- Avoid bouncing checks
- Additional charges
- Interest charges
- Encourages overspending
- Only a temporary solution
How to Avoid Overdrafts Completely
Avoiding overdraft fees is one way to save money, but the goal should not be to incur overdraft fees. The real problem is not the overdraft fees, but rather the overdraft of your checking account in general. Here are some reliable ways to protect your account against overdrafts.
Keep excess funds in your checking account
Avoid having a low balance by keeping extra cash in your checking account. Add more funds as needed to make sure there is always a buffer in your account to avoid a zero balance.
Track your balance and spending
Keeping an eye on your account is one of the best ways to avoid overdrafts. The more in tune with your money and spending, the better off you’ll be. You can do this by downloading your bank’s mobile app, using accounting software, or using one of the many application budgeting now available.
Tracking your balance allows you to verify your account before making purchases or paying bills. Make sure to account for any transactions that haven’t cleared yet, especially as your balance is approaching zero.