Even the most budget-conscious person can overestimate their checking balance and overdraw their account from time to time. Overdraft protection helps you to avoid incurring non-sufficient funds (NSF) fees, which financial institutions could charge when you donât have enough cash in your account to cover a transaction.
The trouble is institutions have widely varying terms for overdraft protection plans: Some are free; others charge additional fees. Confusing, right? Pay a fee to avoid a fee?
If you donât grasp fully how it works, you arenât alone. A survey by The Pew Charitable Trusts found that overdraft protection isnât widely understood by bank customers. In fact, Pew found that nearly three out of four people who overdraw their account donât realize that they have the right to have transactions declined without a fee if their account canât cover the purchase.
Although it has the potential to help, you have to understand the terms of the plans available to you. Letâs take a closer look at the different options.
An overdraft is when you write a check or make an ATM or debit card transaction for an amount thatâs more than the funds available in your checking account. Banks and credit unions typically charge NSF fees when you overdraw your account. Overdraft protection covers the difference if you overdraw your account and prevents you from incurring an NSF fee.
Broadly speaking, three plans are available from financial institutions:
In 2010, the Federal Reserve issued a rule regulating overdraft practices that banned banks from enrolling customers in overdraft protection automatically. Now banks must allow customers to opt in and opt out at any time.
If you opt in, your financial institution might charge a fee to cover check, debit card and ATM overdrafts. This fee typically is a fixed amount thatâs charged per overdraft item. These are the fees associated with the three general types of overdraft protection plans detailed above:
Although you potentially can be charged an overdraft fee multiple times if you continue to overdraw your account, banks typically limit the number of fees you can be charged in one day. If you refuse overdraft protection, your bank or credit union will decline your transaction, so you wonât be charged an overdraft fee, but you might be charged an NSF fee.
If you donât have overdraft protection when you try to make a purchase without having sufficient funds in your account, the bank or credit union will deny the transaction and charge you the NSF fee. States limit the amount a bank can charge, typically ranging from $20 to $50.
If you donât have sufficient funds in your account to cover a transaction but youâve opted in, you avoid paying an NSF fee and the transaction is accepted. You still might be charged an overdraft fee, however. NSF and overdraft fees are somewhat similar, but at the end of the day, theyâre different animals.
Itâs difficult for us to recommend a plan that charges fees. Replacing NSF fees with overdraft fees is a poor strategy if you have trouble keeping your checking account balance high enough to cover your expenses.
The sole advantage of overdraft protection is that your transactions arenât denied. If you have to make an emergency purchase for any reason, it gives you peace of mindâfor a price.
For example, say you have a $0 balance in your account but your car has a flat tire. You have your checkbook, so you can pay for the tow and service. In this case, overdraft protection is helpful.
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. However, overdraft fees are an extremely expensive way to cover necessary expenses. A much better strategy is to learn how to make a budget and stick to it.
Itâs smart to skip overdraft protection if you arenât good with budgeting, because the service can become a crutch that makes you less likely to pay attention to your spending. Overdraft fees can stack up fast when youâre shopping and you donât realize youâre overdrawing your checking account.
For example, say your checking account charges a $34 overdraft fee up to four times per day. Youâre unaware you have a low $10 balance in your checking account. At the mall, you use your debit card to make three separate purchases: pants for $20, a book for $10 and a coffee for $5. You spent $35 on merchandise while racking up $102 in overdraft fees.
In the example above, itâs obvious that it wouldâve been better to opt out of overdraft protection and have your financial institution deny the charges. A better strategy would be to choose an checking account with no overdraft fees, such as the ones below, that donât let you overdraw your account and donât charge NSF fees:
The tips below provide more strategies to avoid overdrawing your account. They also are best practices when it comes to your financial life: