Cash News
If you’ve ever tried to spend more money than was in your checking account, you know how frustrating, costly, and even embarrassing this can be. Overdraft protection, a service offered by many banks and credit unions, can prevent this situation. But like overdrafting your account, overdraft protection may come with its own costs.
What does it mean to overdraft your account?
Overdrafting happens when you spend more money than you have in your account. For example, if you make a purchase of $1,000, but only have a balance of $900, the transaction would overdraft your account by $100.
For many, overdrafting is more likely to happen within a checking account. You may accidentally overdraft when paying with a debit card, making an ACH payment, or when someone cashes a check you wrote for more than your account balance. However, overdrafting can also happen within your savings or money market account.
Overdrafting has consequences. Typically, customers are required to give prior consent that allows their financial institution to impose an overdraft fee when a debit transaction causes their balance to go negative. Overdraft fees, which cost as much as $35 per transaction, can add up quickly. And if you get into the habit of frequently overdrawing your account, your bank may even close your account.
If you opt out of overdrafts, your bank can’t charge overdraft fees. However, the bank might decline transactions that would result in an overdraft instead.
What is overdraft protection?
Overdraft protection is a feature that allows a transaction to go through even when you don’t have sufficient funds in your account to cover it. It acts as an extra cushion for your account and helps you avoid the inconvenience of a declined transaction.
Banks aren’t required to offer overdraft protection. For those that do, the fees, features, and policies vary by financial institution.
How does overdraft protection work?
As an account holder, you can decide whether or not you want to enroll in overdraft protection. If you do, you may have the option to link another account to cover your overdrafts. This could be a savings account, credit card, or line of credit. When you overdraw your checking account, the overdrawn amount is transferred from your linked account to cover the difference. Keep in mind that if you use a credit card or line of credit to cover the overdraft, you may be charged interest on the balance until it’s paid off.
You may have to pay a fee every time a transaction is covered by overdraft protection. There may also be limits on the amount you can overdraft. For example, if your bank has an overdraft limit of $200, you won’t be able to spend more than $200 after your account balance hits zero.
Some banks offer free overdraft protection. Others may offer a grace period of a day or two during which you can deposit money into your account to cover the overdraft. Check your bank’s specific overdraft policies to make sure you understand its fees and features.
Pros and cons of overdraft protection
While overdraft protection can be helpful in certain ways, it has its drawbacks, too. Weigh the following pros and cons before enrolling in overdraft protection:
Pros
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Save time: Enrolling in overdraft protection means you won’t have to deal with the inconvenience and embarrassment of a declined transaction.
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Save money: Bank fees can add up quickly without overdraft protection, including overdraft fees, nonsufficient funds (NSF) fees, late fees, and merchant fees. Though overdraft protection isn’t always free, it can be cheaper than the alternative.
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Have peace of mind during emergencies: If an emergency happens and you need to make a quick purchase, the last thing you want is a declined transaction. Overdraft protection can help eliminate additional stress during an emergency.
Cons
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May encourage overspending: Overdraft protection addresses a symptom of overspending, not the problem of overspending itself. With extra protection in place, you might be tempted to overspend more often.
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Overdraft protection can be costly: Overdraft protection can come with its own set of fees. If you’re not careful, they can add up.
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May not cover all transactions: Not all transactions may be covered by overdraft protection. For example, if you exceed your bank’s overdraft limit, you may be on the hook for overdraft fees.
Ways to avoid overdraft fees
Enrolling in overdraft protection is one way to avoid overdraft fees, but this service often comes with fees of its own. Plus, relying on overdraft protection can reinforce some bad financial habits.
There are other ways to avoid overdraft fees and fees associated with overdraft protection. Consider the following strategies:
Opt out of overdraft protection
If you don’t think you need overdraft protection — or you don’t want to enable overspending — you can always opt out of overdraft protection. This may cause some inconvenience and embarrassment if your payment is declined at the register. But if you’re careful not to overspend, you can avoid both overdraft fees and the cost of enrolling in overdraft protection.
Set up bank alerts
Mobile and online banking make it relatively easy to keep close tabs on your account balances. You may be able to set up bank alerts for low balances or upcoming bills. That way, you can transfer money into your account before your balance hits zero without having to rely on overdraft protection.
Use a budgeting app
A budgeting app can help you track your purchases and avoid overspending. Many of the best budgeting apps link to your bank accounts so you don’t have to do the heavy lifting. A budgeting tool may take some upfront work to get it set up, but can help you get in the habit of only spending what you have.
Consider banks that don’t charge overdraft fees
You can avoid overdraft fees altogether by choosing a bank that doesn’t charge them. Chime, Capital One, and Ally Bank all offer checking accounts with no overdraft fees. And some banks even offer fee-free overdraft protection options.
Read more: The best checking account bonus offers and promotions today
Frequently asked questions
Is getting overdraft protection a good idea?
Getting overdraft protection may be a good idea if you’re worried about overdrawing your account. As long as you don’t rely too much on overdraft protection — or pay excessive fees for the service — overdraft protection can help you reduce the cost and inconvenience of a declined transaction. On the other hand, if it encourages you to overspend, you may be better off without it.
Is overdraft protection free money?
No, overdraft protection isn’t free money. When a bank offers overdraft protection — even free overdraft protection — you ultimately have to cover the overdraft amount. And if your bank charges fees and/or interest for overdraft services, you’ll have to pay those, too.
How much will a bank let you overdraft?
The amount you can overdraft varies by bank. Chime, for example, lets you overdraft up to $200. Ally Bank enables you to overdraft up to $250. Often, banks offer tiered overdraft limits. That means you may be able to qualify for a higher overdraft limit by meeting certain criteria such as setting up direct deposit or maintaining a certain amount of money in your account each month.