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 2. Banking 101: Overdraft Protection: What is it and How Does It Work?


BANKING 101: OVERDRAFT PROTECTION: WHAT IS IT AND HOW DOES IT WORK?

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POSTED BY DepositAccounts

Written by Dillon Thompson | Published on January 30, 2020

Note: This article is part of our Basic Banking series, designed to provide new
savers with the key skills to save smarter.



Overdraft protection is a service that prevents you from paying extra fees if
your checking account balance drops below zero. Overdrafting occurs when you
spend more money than you have in your checking account — it’s something that
can happen to even the smartest and most fiscally responsible consumers. Read on
to understand exactly how overdraft protection works, what fees you could end up
paying and whether the service is worth using.

In this article we will cover:
 * What is overdraft protection?
 * How does overdraft protection work?
 * How much are overdraft protection fees?
 * How to avoid overdraft fees
 * Overdraft protection pros and cons
 * Should you opt in to overdraft protection?


WHAT IS OVERDRAFT PROTECTION?

Overdraft protection is defined as a service that prevents you from paying
non-sufficient funds (NSF) fees. Banks and credit unions charge you an NSF fee
if you write a check, withdraw an amount at an ATM or make a debit card purchase
for an amount that is greater than the funds available in your checking account.

NSF fees typically range from around $20 to $35, and most banks will charge
multiple NSF fees per day if you’ve overdrawn your account and keep making
purchases. So if you were out shopping and didn’t realize that your account was
overdrawn, you could end up being charged multiple NSF fees each time you pay
for things with your debit card. Overdraft protection is one way to avoid this
scenario.


HOW DOES OVERDRAFT PROTECTION WORK?

Many, if not most, banks and credit unions offer overdraft protection services.
Financial institutions offer three main types of overdraft protection plans:

 * Regular overdraft protection: Your institution covers the amount you
   overdraft in each transaction. The institution then charges you a fee for
   each overdraft, up to a daily limit.
 * Overdraft protection via linked account: Your institution allows you to link
   your checking account to another account, such as a savings, money market,
   credit card or second checking account. Your primary checking draws funds
   from the linked account if you’re overdrawn. Overdrafts paid for with fund
   transfers may still trigger a fee.
 * Overdraft protection line of credit: Your institution provides you with a
   line of credit that provides funds to cover overdrafts. A variable interest
   rate is charged for the line of credit, and each overdraft may still incur a
   fee.

It’s important to understand that your bank or credit union’s overdraft
protection plan is voluntary. These programs used to come automatically with
many checking accounts, but in 2010 the Federal Reserve issued a rule that
prevented financial institutions from automatically enrolling their customers in
overdraft protection.


OVERDRAFT PROTECTION EXAMPLE

Say you have $900 in your checking account, and you write a $1,000 check to pay
your monthly rent. By the time you realize you’ve overdrafted your account, it’s
too late: The check has been cashed and your account is now $100 in the
negative.

That’s where your overdraft protection steps in. Perhaps you’ve linked your
checking account to a separate savings account, which has more than enough money
to cover the difference. Your bank will automatically transfer some of that
money over to pull you out of the negative. But remember, most banks and credit
unions charge a fee for overdraft protection.


HOW MUCH ARE OVERDRAFT PROTECTION FEES?

Overdraft protection fees and policies vary by bank or credit union. Overdraft
fees can range between $10 and $15. Here are a few examples:

 * Wells Fargo overdraft protection: Wells Fargo charges $12.50 to transfer
   funds from your savings account, as well as $12.50 from a line of credit
   account. However, if you have a home equity line of credit account linked to
   the bank’s Portfolio Checking account service, there’s no fee.
 * Bank of America overdraft protection: Bank of America charges a $12 fee to
   transfer funds from a linked checking or savings account; however, there’s no
   fee for overdrafts of $1 or less.
 * Chase Bank overdraft protection: Chase Bank doesn’t charge any fee for its
   overdraft protection service; however, the bank does note that customers will
   be charged a $5 savings withdrawal fee if they transfer funds from their
   savings account more than six times per month.

Another thing to keep in mind: You’ll face potentially high APRs if you opt into
a line of credit instead of a checking or savings account. It’s worth checking
with your bank on this one, but many rates are around 20% of the overdrafted
amount.


HOW TO AVOID OVERDRAFT FEES

If you decide not to enroll in an overdraft protection program, you have
alternatives. First and foremost, avoid letting your balance drop below zero.
That’s not always easy, but here are some helpful methods to avoid overdrafts: 

 * Set up low-balance alerts: You can ask your bank to notify you if your
   account drops below a certain amount. These alerts can come as texts, emails
   or even push notifications — that way, you can choose that option that will
   reach you most easily.
 * Check your balance often: This one sounds simple, but it never hurts to check
   your bank accounts at least once a day. In addition to helping you avoid
   overdrafting, it will also keep you aware of your daily spending habits.
 * Create a budget: If you’re worried about overspending, keeping a budget is a
   great way to limit your purchases. Taking a hard look at your finances will
   allow you to see where you can cut costs and live within your means.
 * Use a prepaid card: These paid-in-advance debit cards aren’t linked to a bank
   account, meaning there’s no way you can spend more than you have. It’s easy
   to add funds to a prepaid card — you can do so at most grocery stores and
   convenience stores — making this an easy option if you know you’ll be making
   several purchases in a short time span.


OVERDRAFT PROTECTION PROS AND CONS

Overdraft Protection Advantages Overdraft Protection Downsides Avoid paying high
NSF fees You could still face overdraft protection fees Checks may clear even if
your balance is low It may provide an excuse to overspend You don’t have to
worry about your card being declined Banks may charge interest rates for line of
credit transfers You can make large purchases if there’s an emergency If you
link accounts, transactions won’t clear if you don’t have enough in your linked
account


IS OVERDRAFT PROTECTION A GOOD IDEA?

Overdraft protection can be a great way to avoid costly NSF fees and ensure that
you always have enough money to make purchases — but on the other hand, it might
not be worth signing up if you’re not someone who’s worried about overdrafting
often and exchanging one kind of fee for another. Everyone’s financial situation
is different, so it ultimately depends on your own experience and spending
habits.

You also have to consider the cost, as you could face annoying fees or high
interest rates, depending on what’s linked to your checking account. Ultimately,
it’s worth assessing your spending habits — and comparing the options available
at your bank — before making a final decision.

Fees mentioned in the article are accurate as of the date of publishing.



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