What is an overdraft fee?

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In a Nutshell

An overdraft fee is charged when a payment or withdrawal from your bank account exceeds the available balance and your bank covers the transaction as part of an overdraft protection service. But in addition to covering the transaction, the bank or credit union then applies the fee.
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Overdraft fees are charged when you don’t have enough cash in your account to cover a payment you’ve made, and as part of an overdraft protection service, the bank covers the difference for you.

Overdraft fees average around $34 for banks. Frequent overdrafters pay almost $450 more in overdraft fees every year than somebody who’s not enrolled in an overdraft protection program.

Let’s take a closer look at how overdraft fees work, how much they cost you and how you can avoid them so you can save more of your money and better manage your finances.

What is an overdraft fee? 

An overdraft happens when you don’t have enough money in your checking or savings account to cover a withdrawal or payment and the financial institution then pays for the transaction anyway, which yields a negative balance in your account.

Usually, financial institutions will charge you for this transaction, and that cost is what’s known as an overdraft fee.

Also included in this fee is the amount the bank lent you to cover the difference between what you had in your account and the actual payment total.

Federal regulators made it mandatory for certain financial institutions to obtain your consent before adding you to an overdraft protection program that charges an overdraft fee on most ATM and debit card transactions. When opening a checking or savings account, you must opt in to overdraft protection, which allows the institution to apply a fee.

Overdraft fees may not apply to automatic payments or checks. But beware: Certain banks or credit unions may return checks or transactions unpaid, resulting in a “nonsufficient funds,” also known as a NSF, fee. This fee tends to be a similar amount to an overdraft fee. But if your financial institution rejects a debit card transaction, you may not be charged a fee.

How much are overdraft fees really costing you?

Overdraft fees can add up if you’re not careful. In fact, the Consumer Financial Protection Bureau estimates that overdraft and NSF fees together cost Americans $7.7 billion in 2022. These fees amount to the single-largest banking-related expense for consumers who own a checking account.

According to the CFPB, most overdraft fees are incurred by debit card transactions of $24 or less and are repaid within three days. Consider overdraft fees in a lending context: If you were to take out a $24 standard loan and pay an additional $34 to borrow the funds for three days, this loan would have a 17,000% APR.

Overdraft fees are an unnecessary expense, and learning how to avoid them can help you save money.

Strategies for avoiding overdraft fees

Overdraft fees can put a dent in your budget. But there are a few strategies you can implement to help you prevent paying this costly expense.

Sign up for online banking

Online banking is one of the benefits many financial institutions offer. Signing up for online banking allows you to track and watch your checking and savings accounts closely. You can monitor money coming in and going out.

Track your expenses

You can track your expenses in many ways. You can track them online or by using a written check register to record all of your transactions. It’s a good idea to record all of your deposits and withdrawals. This will help you maintain a running account balance.

Set up balance alerts

Some financial institutions will alert you when your account dips below a specific amount. By establishing account alerts, you’ll know when to transfer or deposit more money into your account to cover any upcoming transactions that could lead to a negative balance.

Keep a cushion in your account

Keep a little extra money in your account to cover unforeseen expenses. This can help prevent accidentally overdrafting your account.

Ask your bank for alternatives to overdraft protection

Some banks and credit unions have alternatives to overdraft protection. For example, certain financial institutions will allow you to link your savings account to your checking account. When you overdraw your checking account, funds from your savings account will be transferred, providing similar service as overdraft protection.

Keep in mind, there will likely be a fee for this transaction, but it tends to be less than an overdraft fee.

Ask your bank or credit union about other overdraft protection options.

What’s next?

Paying an overdraft fee is a costly and often unnecessary expense. Some of the best ways to avoid overdraft fees include understanding your financial institution’s overdraft policy, tracking your expenses and staying within a budget. Being proactive will not only help you prevent overdraft fees, but it will help you successfully manage your money.

About the author: Ashley Chorpenning is a personal finance writer and content creator. In addition to being a contributing writer at Credit Karma, she writes for solo entrepreneurs and Fortune 500 companies. Ashley has a Bachelor of Bu… Read more.