What is overdraft protection?

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In a Nutshell

Overdraft protection is an added feature to a bank account that automatically transfers money from a separate designated account to cover a shortfall in the primary account.
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An overdraft is when you don’t have enough money in your checking account to pay for a purchase, but your bank or credit union covers the payment anyway. When that happens, the bank often charges you a fee and makes you pay back the overdrafted amount — this is overdraft protection.

Let’s face it — anyone can make an honest mistake. We may forget to make a deposit or forget that we paid for a particular item. There are a number of reasons why bank account holders may make a miscalculation or minor budget oversight — even for the most financially savvy among us.

Overdrawn accounts can incur hefty overdraft fees, sometimes adding on to an already-burdened consumer’s debt load. Overdraft protection is a financial safety net for checking account holders — but it might not be the best option for everyone.

The fundamentals

Although financial institutions operate independently from one another, offering some sort of overdraft protection is routine. As a checking account holder, you can add or remove overdraft protection during the life of your account. When signing up for overdraft protection, you will need to link at least one backup account (like a savings account or credit card) to your checking account. If the checking account does not have the funds to cover a transaction, then funds are automatically pulled from one of the linked accounts to cover the amount.

The fees

Naturally, this safety net comes with a cost. Most overdraft protection fees generally average at about $12. Mind you, this minimal price seems rather reasonable when compared to the average $34 overdraft fee, which can be charged per transaction.

Eligible linked accounts may also have additional fees that vary according to the amount advanced to cover the transactions. For a complete understanding of these fees, the amounts and when they may be charged to your account, make sure to read the fine print of your credit card’s agreement and terms policy before opting in to overdraft protection.

Does everyone need overdraft protection?

The short answer is “no,” but, of course, a simple answer like that won’t cut it when dealing with finances.

Overdraft protection can be beneficial for new account holders, such as students who are on a budget and learning to responsibly manage their money — or for those who rely on payday to replenish their accounts.

Signing up for overdraft protection can spare the embarrassment of a declined purchase, and it can also help to cover an emergency purchase when in a pinch. Of course, remember that each overdraft is essentially an expensive loan from the bank when you add in the fees. Try your best to avoid them if at all possible.

Feel as if overdraft protection isn’t for you? No problem! Many banks offer accounts that allow the account holder to opt out or decline all overdraft protection services. If an account does not have the means to cover a transaction such as a debit purchase, ATM withdrawal or electronic payment, the transaction will be declined or the item will be returned. Opting out of overdraft protection is a sure way to avoid any overdraft fees from the bank, although be wary that other fees could be applied.

Can my bank automatically enroll my account in overdraft protection?

No. Under the Overdraft Protection Act, banks can no longer automatically enroll customers in overdraft coverage or protection; the customer makes the ultimate decision.

How to avoid overdraft fees

Let’s be honest — the banking industry is a business focused on making money, and one way of doing that is by charging their customers various fees. Although some fees are unavoidable, account holders can avoid most fees and keep their hard-earned dollars for themselves.

  • Sign up for account alerts, such as payment reminders and low-balance alerts
  • Frequently monitor your account for unusual activity or spending
  • Keep some extra cash in the checking account, if possible, to avoid a low balance
  • Sign up for account services that automatically replenish a low-balance account
  • Opt out of any overdraft protection services

Before signing up for a checking account, do some research and read the bank’s fine print on its fees. Some banks, such as Wells Fargo, may offer to have overdraft fees waived if the full amount is deposited into the account by a specified time on the same business day.

Whenever there is a fee charged to your account, call a customer service representative and ask to have the fee waived. An appeal to a customer service representative could be successful. It’s worth a shot, isn’t it?

Next steps

Adding overdraft protection to an account is a practical and relatively inexpensive safeguard against potentially hefty overdraft fees. Before adding this optional protection to an account, you should scrutinize your spending habits and account management skills to determine if you truly need this added protection. Overdraft protection isn’t necessary for everyone.

If you tend to keep a low balance in your checking account and don’t keep a close eye on spending habits, then overdraft protection could be for you. If you’re fortunate enough to keep a cushion of cash in your checking account and make it a point to routinely monitor your account, then overdraft protection may not be necessary. If you’re on the fence, remember that nothing is set in stone; overdraft protection can be added or removed from your account.

About the author: Sarah Schaut is a Canadian living in sunny Florida. She’s an economic crimes detective at a city police department and an expert in credit, fraud and mortgages. Read more.