You may be wondering if getting overdraft protection at your bank can help you to avoid overdraft fees. The answer is yes … and no. Overdraft protection is a service banks and credit unions provide to help customers avoid nonsufficient funds (NSF) fees they will incur if they don’t have enough cash in their account to cover a transaction. While some overdraft protection plans are free, others charge fees.
Pay a fee to avoid a fee? You may wonder, why bother? But depending on your situation, overdraft protection has the potential to help if you understand the plan terms.
- What is overdraft protection?
- How does overdraft protection work?
- What are overdraft fees and how much do they cost?
- Pros and cons of overdraft protection
- Is overdraft protection right for you?
What is overdraft protection?
If you write a check, visit an ATM to withdraw money, pay for a purchase with a debit card or have an automated payment post on your account and you don’t have sufficient funds, your bank could charge you an NSF fee.
If you have overdraft protection, however, your financial institution will automatically complete the transaction through a variety of methods, preventing you from incurring an NSF fee. However, they often charge an overdraft protection fee, which typically is a fixed amount that’s charged per overdraft item.
In 2010, a Federal Reserve-enacted rule regulating overdraft practices banned banks from enrolling customers in overdraft protection automatically. Now banks must allow customers to opt in to overdraft protection when they open an account, and you can opt out at any time.
How does overdraft protection work?
Banks typically offer three types of overdraft protection. With standard overdraft coverage, the bank covers the amount, generally charging a fee for each overdraft transaction.
You can also link your account to a line of credit. In this scenario, the bank will transfer funds to cover the overdrawn amount and any fees charged. The overdrawn amount is subject to a variable interest rate, and each overdraft might incur a separate fee.
Or you can link your checking account to a savings, money market, credit card or second checking account. With this option, your primary checking account draws funds from the linked account if you’re overdrawn. However, the transfer of funds might result in an overdraft protection fee.
What are overdraft fees and how much do they cost?
If you opt in to overdraft protection, your financial institution might charge a fee to cover an overdraft, although many cap the number of overdraft fees you can be charged per day. First there is the standard one-time overdraft protection plan, which is typically at least $34 per overdraft. An additional fee might apply if your account remains overdrawn for a certain length of time. The chart below provides information on standard fees for several banks.
|Standard One-Time Overdraft Protection Fees for Banks|
|Institution||Overdraft fee (per item)||Maximum fees per day|
|Bank of America||$35||$140|
If you opt for an option other than the standard overdraft plan your bank offers, you may incur the following costs instead of those outlined in the table above:
- Overdraft protection line of credit: Typically at least $10 per overdraft and an APR of around 20% charged on the covered amount.
- Linked account overdraft protection: Typically $10-$12 per transfer. If you link a credit card account in this way, payments are considered to be cash advances. This means paying an APR of at least 26% on the overdraft amount, plus a fee that could be as much as 5% of the overdraft amount.
Some banks may offer special plans to protect you from overdrawing your account. For example, Wells Fargo has an overdraft rewind program that allows you to avoid an overdraft fee from some transactions that leave you with a negative checking account balance, as long as you make a direct deposit to make up the deficit by 9 a.m. the following day. This program is automatically applied to all checking accounts.
Pros and cons of overdraft protection
- You can cover important purchases. If you’re in an emergency situation, overdraft protection can provide you with a way to pay for important purchases. This could be helpful if you currently don’t have enough money in your account and are near your next payday, and you need to make an immediate purchase and have no other means of payment, such as credit cards.
- You avoid embarrassment. You don’t have to worry that your debit card will be declined during purchase checkout, which can be awkward, especially if you don’t have another form of payment handy.
- You avoid bounced checks. Nonsufficient funds can result in your check being returned to the payee. In some cases, you may incur fees from the payee as well, who may be charged by their financial institution, too.
- You won’t incur expensive late fees. If you can’t pay your rent or car payment on time, your landlord or lender may impose late fees. In some cases, they could be more than an overdraft fee, but overdraft protection could allow you to make your payment on time.
- Fees can add up quickly. Overdraft protection fees can stack up fast when you’re shopping and don’t realize you’re overdrawing your checking account. You could hit the maximum fees per day without even knowing it.
- You may become less attentive to your finances. People who live paycheck to paycheck or who have inconsistent income might be tempted to rely on overdraft protection to cover necessary purchases when they might not have the money.
- You could overspend. If you aren’t good with budgeting, overdraft protection could become a crutch that tempts you to spend more than you have.
- You can incur expensive interest charges. If your overdraft protection plan is linked to a credit card or line of credit, you can rack up interest charges on top of the fees your bank may charge.
Is overdraft protection right for you?
The key advantage of overdraft protection is that your transactions aren’t denied. So overdraft protection can give you peace of mind — but for a price. Replacing NSF fees with overdraft protection fees is a poor strategy if you have trouble keeping your checking account balance high enough to cover your expenses.
Alternatives to overdraft protection
- Set up low-balance alerts. Many banks allow you to set alerts when your balance reaches a certain amount. This is a helpful feature that can make you aware when funds run low and when you should minimize spending.
- Review your account balances. Regularly keep track of how much money is in your checking account. Log in to online banking or maintain a paper or electronic register to stay up-to-date on your account balance so you know how much you can afford to spend.
- Choose a bank with no overdraft fees. Not every bank charges these fees. Here you can see a list of checking accounts that charge no overdraft fees.
- Link your accounts for instant transfers. If you know you’re going to make a purchase and don’t have money in your account, you can have a savings account or money market account linked to your checking account to facilitate instant transfers. This way, you can cover a purchase without waiting for funds to clear. However, you should understand that you may have to pay fees for such a fast transfer of funds.