Advertiser Disclosure

Strategies to Save

Understanding How Overdraft Protection Works

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Understanding how overdraft protection works
Source: iStock

Have you ever written a check for an amount you didn’t have in your account and incurred a fee? Or have you ever been embarrassed by a declined debit card transaction? If the answer’s yes, you’ve had experience with overdrawn checking accounts.

You may have heard about overdraft protection and how it may help you pay for expenses when you lack the funds in your account. While this service has the potential to help you in times of need, it’s important to be aware of the drawbacks. In this post, we’ll discuss the ins and outs of the various types of overdraft protection, and how you can avoid overdrawing your account in the future.

Featured checking account with no overdraft fee

Institution
APY
Minimum Deposit Amount
Personal Account from nbkc bank
nbkc bank

1.01%

$0

LEARN MORE Secured

on nbkc bank’s secure website

Advertiser Disclosure.

We'll receive a referral fee if you click here. This does not impact our rankings or recommendations.

Your deposit is FDIC-insured up to the maximum limit.

What is overdraft protection?

Overdraft protection is a way to fund an account that has been overdrawn. Without this service, you would most likely be charged an overdraft or non-sufficient funds (NSF) fee and have your transaction declined. The fees can add up every time your account is overdrawn, but this service can provide a safety net if you withdraw too much money.

How does overdraft protection work?

There are three types of overdraft protection that work in slightly different ways. While they ultimately transfer funds to your overdrawn checking account, the fees charged differ.

Here are the three options you may have for overdraft protection:

  1. Opt in for overdraft coverage for ATM and one-time debit card transactions. By opting in, you authorize the bank to pay any overdrafts from ATM and one-time debit card transactions. Beware banks often charge you high fees.
  2. Link your checking account to an eligible savings, secondary checking, money market account or line of credit like a credit card. If your account is overdrawn, funds will be transferred from your linked account. There is often an overdraft protection fee associated with the transfer of funds.
  3. Overdraft protection line of credit. If you overdraw your account, the line of credit transfers funds to cover the amount overdrawn plus any fees charged. The amount you overdraw is subject to a variable interest rate and a fee. Note, some banks may require a minimum annual income to open an overdraft protection line of credit.

Overdraft protection fees

If you have overdraft protection and overdraw your account, you will most likely be charged a fee. This fee is often a fixed amount that is charged per overdraft item and varies based on the protection you have.

Here are the fees associated with the options detailed in the previous section:

  1. Opt in for overdraft coverage for ATM and one-time debit card transactions: Typically $34 per overdraft item and an extended overdraft fee may apply if your account is overdrawn for a certain amount of days.
  2. Link your checking account to an eligible savings, secondary checking, money market account or line of credit like a credit card: Typically $10-$12 per transfer.
  3. Overdraft protection line of credit: Typically $10 or more per transfer, plus an APR of around 20% charged on the amount transferred.

While you can potentially be charged the fee multiple times in one day if you continue to overdraw your account, banks typically limit the amount of times you can be charged the fee in a day.

Understanding the overdraft protection law

In 2010, the Federal Reserve passed a law regulating overdraft practices for one-time debit card and ATM transactions. The law banned banks from automatically enrolling customers in overdraft protection for these transactions.

Prior to this law being passed, banks were allowed to process one-time debit card and ATM transactions in which consumers lacked the necessary funds and were charged an overdraft fee. But, the law changed that practice and required banks to allow customers to opt in or opt out of overdraft protection at any time.

If you opt in, the bank will process your one-time debit card and ATM transactions and charge a fee. While if you opt out, the bank will decline your transaction and won’t charge you an overdraft fee — but they may still charge an NSF fee.

The benefits of opting in to overdraft protection

Transactions are approved. This service may be helpful if you need a transaction to go through and can’t afford to have it declined in cases of emergencies or upcoming due dates on bills.

Less embarrassment when paying. If you’re someone who lives from one paycheck to the next, you may run into instances where you’re short of funds for needed expenses like groceries. It can be embarrassing to have your debit card declined due to insufficient funds, and this service may help you avoid those situations.

When can you benefit from overdraft protection?
You may benefit from overdraft protection if you find yourself in a situation where you don’t have the money to cover the cost of an unexpected emergency. For example, say you have a $0 balance in your account but your car broke down because of a flat tire. In this situation, you have your checkbook but don’t have the needed cash or credit card to pay for the tow and service on your card.

If you enrolled in this service and linked an eligible savings account that has the needed funds, you could write the check. Then, the bank would transfer the funds from your savings account to your checking account. You would be charged a $10-$12 overdraft transfer fee, but that’s minor compared to the typical $34 NSF you would be charged if the check bounced.

The drawbacks of using overdraft protection

Fees may still apply. If you enroll in overdraft protection, you may still be charged fees, such as an overdraft protection fee or an NSF fee. And you may incur multiple fees in one day.

High fees for overdrafts funded by credit cards. If you use a credit card to fund your overdraft, it is considered a cash advance which often comes with high APRs over 25% and a cash advance fee that is 3% or 5% of your withdrawal.

When is overdraft protection not worthwhile?
If you opt in for overdraft protection on ATM and one-time debit card transactions and make unnecessary transactions when you have a $0 balance, you can see fees add up quickly. For example, say your account charges a $34 overdraft fee up to four times a day. You’re unaware you currently have a $0 balance in your checking account.

You decide to go to the mall and use your debit card to make three separate purchases: pants for $20, a shirt for $10, and a hat for $8. In total you spent $38 on clothes, but incurred $102 in overdraft fees. That makes the effective cost of your clothing purchase an alarming $140. It’s pretty obvious that it would’ve been a better decision to opt out of the service for ATM and one-time debit card transactions so those transactions would’ve been declined.

Which type of accounts can be linked to a checking account for overdraft protection?

You can link several accounts to your checking account for overdraft protection, including: savings, secondary checking account, money market or line of credit like a credit card. Note that linkable accounts may vary by bank, so refer to your overdraft protection agreement for eligible accounts.

How to avoid overdrawing your account

If you want to prevent future overdrafts, the tips below may help you avoid overdrawing your account, and are general best practices when it comes to financial products:

  • Open a checking account with no overdraft fees. There are banks that offer checking accounts with no overdraft fees. So, instead of being hit with the average $34 fee, banks most likely will decline the transaction — if you aren’t opted into overdraft protection.
  • Don’t overspend. You may have trouble managing your spending, which may lead you to overdraw your account. You can create a budget to get a better picture of your finances and see where you can cut costs to avoid overdrawing your account. A good rule of thumb is don’t spend more than you can afford.
  • 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 are running low and when you should minimize spending.
  • Review your account balances. It’s important to keep track of how much money is in your checking account. You can keep a register or log in to online banking to stay up-to-date on your account balance. This way, you know how much you can afford to spend.
  • Don’t write checks before you have the money in your account. You may run into issues if you write checks in advance of having the necessary funds in your account. While you expect to have the needed funds in your account when the check is cashed, things may change and result in you lacking the funds to fulfill the check.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Alexandria White
Alexandria White |

Alexandria White is a writer at MagnifyMoney. You can email Alexandria at alexandria@magnifymoney.com

TAGS:

Advertiser Disclosure

Strategies to Save

Where People Save the Most: Super Saving Metros

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Give credit to the residents of Dubuque, Iowa. They saved their pennies last year, according to a recent study by MagnifyMoney.

Dubuque earned the highest Saving Score in MagnifyMoney’s Super Saving Metros report, which looks at the savings habits of residents living in the biggest metropolitan areas across the United States.

Relying on data from the IRS and U.S. Census Bureau, MagnifyMoney created a Saving Score for nearly 400 U.S. metropolitan areas. This score reveals:

  • Which areas boasted the greatest percentage of adults who earned money from interest-bearing vehicles, such as savings accounts and certificates of deposit (CDs)
  • How much interest on average these residents claimed on their 2017 tax returns
  • What percent of their annual income came from interest

We’ve changed our study a bit this year. Instead of looking at cities with populations larger than 25,000, as we have in the past, this year we are looking at savings within entire metropolitan statistical areas. These areas often include several cities and provide a more accurate look at the savings habits of residents within a larger area.

One of our key findings? As a nation, the U.S. doesn’t have a lot of savers. Nationally, 28.3% of U.S. residents who filed income tax returns in 2017 earned interest income on their savings. This interest income averaged $554, equal to 0.76% of filers’ total income for the year.

Not all metro areas are created equal when it comes to savers, though. In Naples, Fla., for instance, filers reported an average of $3,224 of interest income on their taxes last year. But in Pittsfield, Mass., that average was a far lower $481.

There are also significant differences among metropolitan areas in how many residents earn enough interest from their savings to report to the IRS. Filers who earn more than $10 of interest on savings accounts, CDs, money market accounts, high-yield checking accounts or certain types of taxable bonds have to report their interest income. MagnifyMoney found that in Peoria, Ill., 48% of filers reported interest income on their returns. But in Los Angeles, just 30% did.

Key findings

  • Dubuque pulled down the top savings spot among the 381 U.S. metropolitan areas that MagnifyMoney studied. The city had the highest Saving Score, an impressive 97.8 out of a possible 100.
  • Naples, which came in second with a Saving Score of 97, topped the country with the highest amount of average interest income per return, a strong $3,224. Naples also ranked first in highest percentage of interest income compared to total income. Filers here earned an average of 2.33% of their total annual incomes from interest on their savings.
  • Peoria had the highest percentage of filers who earned at least some interest income. About half of the federal tax returns filed here last year had some amount of interest income.
  • Iowa might have been the thriftiest state in the country in 2017. Dubuque notched the highest Saving Score in this year’s study. But the cities of Cedar Falls and Cedar Rapids also earned high scores. This isn’t a one-time fluke either. MagnifyMoney found a similar trend when looking at the numbers from earlier tax years.

What does the Saving Score measure?

It can be challenging to determine how much the residents of a particular metropolitan area are saving. For our study, we crafted a Metro Saving Score that relies on data from the IRS and U.S. Census Bureau for 381 metropolitan areas across the country.

We looked at three key factors to calculate our score:

  • The percentage of all tax returns that declared interest income
  • The percentage of residents’ total annual income that came from interest earned from savings
  • The average interest income recorded on tax returns in a metropolitan area

50 cities with the top Saving Scores


Dubuque led our list of the metro areas with the biggest savers, earning a healthy Saving Score of 97.8. But what’s so special about Dubuque?

The area isn’t especially rich: The U.S. Census Bureau reported that the median household income stood at $56,154 in 2016 in Dubuque County and $48,021 in the city of Dubuque itself. That’s below the median annual household income of the U.S. as a whole, which was $57,617 in 2016. The Census Bureau also said 16.8% of the city’s residents lived in poverty, while 29.7% of residents have earned a bachelor’s degree or higher.

Regardless of the relatively modest incomes here, 44% of tax filers in the Dubuque metro area claimed interest income on their returns. This interest income averaged $781 per return, which accounted for an average of 1.24% of these residents’ annual income.

So why the high savings rate? Maybe it’s the low unemployment rate. The Bureau of Labor Statistics said the unemployment rate in Dubuque was a low 2.2% as of August 2018. It’s easier to save when you’re employed. Also, it’s not that expensive to live in Dubuque. The Census Bureau said the median costs for owners with a mortgage is $1,102 a month, while the median cost for renters is $728 a month.

Things are a bit different in Naples, where the Census Bureau said the annual median income was $84,830 in 2016. It’s important to note that median income isn’t the same as average income. The median is the dollar amount that half of all residents in an area earn less than each year and half earn more. In Naples, half of all households reported an annual income of less than $84,830, while half reported an annual income higher than that.

What is clear, though, is that the residents of this Florida city have more money to save, which might be why Naples ranked second with a Saving Score of 97. Here, 36% of income tax returns included interest income. The interest income per return in Naples was high, too, leading our survey with a hefty $3,224.

In Fairfield County, Conn., which came in third with a Saving Score of 96.3, 36% of tax returns recorded interest income. The interest claimed here was sizable, too, with an average of $2,434 claimed per return. Again, the residents here have more money to save, with the Census Bureau reporting a median household income of $86,670 in 2016.

Santa Barbara, Calif., and Boston rounded out the top five metro areas on our list. Santa Barbara earned a Saving Score of 95.7, with 36% of tax returns here claiming interest income. This income accounted for 1.18% of annual income earned by residents here. The interest income per return in Santa Barbara was a healthy $1,074.

And in Boston, with its Saving Score of 94.2, 37% of returns claimed interest income, with an average per return of $920.

10 cities with the most savers

Dubuque again represented itself well on our list of metropolitan areas with the most savers. But it didn’t top it. The No. 1 spot went to another Midwestern city, Peoria, where 48% of tax returns listed some form of interest income.

What makes Peoria residents such good savers? It’s hard to say. The income here isn’t sky-high, with the Census Bureau stating that the median household income stood at $46,547 in 2016. At the same time, though, it’s not expensive to live in Peoria, freeing up residents to save. The Census Bureau said it cost $1,200 a month for owners with a mortgage, while the median value of a home was $127,200. Those who rented didn’t pay too much, either, with the Census Bureau reporting a median gross rent of $746 a month.

Then there is Dubuque. Again, the income here wasn’t high, but housing isn’t overly expensive, perhaps making it easier for residents to save. The Census Bureau reported that owners with a mortgage paid a median value of $1,102 a month, while those who rented paid a median of $728 a month. Maybe that’s why Dubuque tied for second with 44% of returns claiming interest income.

Dubuque tied for this spot with Ithaca, N.Y., where the same percentage — 44% — of returns claimed interest income. It’s not easy determining how Ithaca residents were able to save so much. The Census Bureau reported that the median annual household income here was just $30,291 in 2016, while 44.8% of the people lived in poverty. At the same time, the median value of owner-occupied homes stood at a fairly high $219,100. This makes Ithaca’s high savings rate a bit of a mystery.

Appleton, Wis., is easier to explain. This area ranked fourth on our list with 42% of returns claiming interest income in 2017. This isn’t surprising: The Census Bureau said the median household income here was $53,878 in 2016, while the median value of owner-occupied homes was a fairly low $137,800. Perhaps residents spent less on housing costs and were able to save more.

Iowa City, Iowa, finished fifth on our list, tied with Appleton with 42% of returns claiming interest income. That percentage was a popular one, with Rochester, N.Y., and yet another Iowa city — Cedar Falls — tying with Appleton and Iowa City.

10 cities that earned the most interest income

Here is a not-so-shocking fact: People who make more money tend to save more of it. That’s proven by our list of metro areas in which taxpayers claimed the most interest on their returns.

Look at Naples. Those living here earned a lot of interest income in 2017. According to our research, the average return filed here in 2017 listed a whopping $3,224 in interest income. That easily topped our list. The reason is fairly obvious: A lot of wealthy people live here.

The city is a costly one, with the Census Bureau showing that the median home value is $770,000, while it costs owners with a mortgage a median $2,987 a month. With those barriers to entry, it’s not surprising that the median household income was $84,830 in 2016. When you earn more, it’s easier to save more — a lesson made clear in Naples.

Fairfield County was second on this list, with the average tax return listing interest income of $2,434 in 2017. Again, this is another high-income area, with the Census Bureau reporting that the median household income was $86,670 in 2016.

Next on our list is Vero Beach, Fla., where the average interest income reported on tax returns stood at a healthy $1,839. This city is a bit more puzzling: The Census Bureau showed that the median household income was a modest $38,405 in 2016. And it’s not particularly cheap to live here, with the Census Bureau stating the median costs for owners with mortgages as $1,654, while monthly rent stands at a median of $829.

Coming in fourth on our list is another Florida tourist metro, Fort Myers, where the average interest income per return was $1,195. This is an interesting place: In the city of Fort Myers, with a population of almost 80,000, the median household income is $38,971. But if you focus on the smaller area of Fort Myers Beach, where the population is just more than 7,000, the median household income is $59,416.

The New York City metro area claimed the fifth spot on this list, with an average interest income of $1,146 reported per return. With a population of more than 8.6 million, New York City itself sees a wide range of yearly incomes. The median household income is $55,191, but plenty of households saw a far higher income than that. This helps explain the Big Apple’s high spot on this list.

10 cities with the lowest Saving Scores

While there are plenty of metro areas where people are saving, there are others that have earned low Saving Scores from our research. In most of these areas, the median household income is low. In others, unemployment is high.

This isn’t surprising: It’s a challenge to save when you don’t make enough and you’re struggling to find a job.

The first metro area on our list of areas with the lowest Saving Scores — Hinesville, Ga. — earned a Saving Score of just 0.5, with 15% of income tax returns filed in 2017 claiming interest income. The average filer here claimed just $80 worth of interest on their returns.

The median household income stood at $42,949 in 2016, according to the Census Bureau. That is below the median household income for the U.S., which the Census Bureau said was $57,617 in 2016.
El Centro, Calif., ranks high on this list, too, coming in second. Unemployment is a problem here, with the Federal Reserve Bank showing the rate at a high 17.2% in El Centro as of August 2018.

Third on our list was Fayetteville, N.C., earning a Saving Score of 1.8. Only 18% of tax returns here claimed interest income in 2017, with the average return listing just $149 in interest income. The median household income was $43,882 in 2016, while 18.4% of the population lived in poverty. The Census Bureau also reported that 14.2% of the people younger than 65 do not have health insurance, a factor that could account for the low savings rate here.

Pine Bluff, Ark., scored a low 3.0 Saving Score with 19% of income tax returns claiming interest income. Pine Bluff’s population is declining, falling to 42,984 in 2017, a drop from 49,083 in 2010 — a dip of 12.4%. At the same time, the median household income was just $30,942 in 2016, while 32.5% of residents lived in poverty.

Rounding out the bottom five of savers was the metropolitan area of Florence, S.C., with a Savings Score of 3.7. Just 17% of returns here claimed interest income in 2017. The median household income here was not terrible, but at $44,989 is still below the median for the U.S.

How to save more money

Need to increase your savings rate? There’s no secret formula. Start with crafting a household budget. List the income that comes into your household each month and the money you spend during the same time. Include both fixed expenses such as your monthly rent, mortgage payment, auto payment or student loan payments while estimating those that vary each month, such as your utility bills, transportation costs and grocery bills. Make sure to also budget for discretionary expenses such as eating out and entertainment.

This budget will tell you how much you should have at the end of the month for savings. If you don’t have much, or if you are spending more than you are earning, you’ll need to cut back on whatever expenses you can. This might require slashing your spending at the supermarket or cutting back on restaurant meals.

Be sure to start an emergency fund, too. You use the dollars in this fund to pay for any unexpected expenses that pop up, such as a busted water heater or blown transmission on your car. If you have this fund built up, you won’t have to resort to paying for these emergencies with a credit card, something that will build up your debt and make it even more difficult to save.

It’s important to note, too, that it might be a bit easier now to earn interest on your savings. That’s because as the Federal Reserve raises its benchmark interest rate, banks and credit unions are starting to do the same, boosting the interest rates attached to their savings accounts and CDs. These rates might still be small, but they are set to improve, so now is a great time to begin saving those dollars.

Methodology

To rank cities, MagnifyMoney created a Saving Score on a scale of 0 to 100 that included three equally weighted components:

  1. How broadly individuals in the metro saved (measured by the percentage of all tax returns that declared interest income, ranked by percentile).
  2. The metro’s dedication to saving regardless of their income (measured by the percentage of total income that came from interest, ranked by percentile).
  3. The absolute magnitude of savings in the metro (measured by the average interest income per tax return, ranked by percentile).

MagnifyMoney measured these factors using anonymized data from tax returns filed with the IRS from Jan. 1 to Dec. 31, 2017.

To be counted as a saving household, the taxpayer must declare interest income using Form 1099 on their 2016 tax returns. Filers who earned over $10 in interest on savings and investments, including a high-yield checking or savings account, a CD, a money market account or certain types of taxable bonds, should have received a copy of 1099-INT, which reflects interest income reported by financial institutions to the IRS.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Dan Rafter
Dan Rafter |

Dan Rafter is a writer at MagnifyMoney. You can email Dan here

TAGS: