Overdraft Protection: Do You Need It?

If you have ever overdrafted your bank account, then you know the pain of overdraft fees. Luckily, many financial institutions offer overdraft protection services that can deal a lesser blow to your finances.

This article will take a closer look at how overdraft protection works and what options you might have available to you.

What is an Overdraft?

Overdrafts are payments from your account that are higher than the available amount. To give an example, let’s assume that you have $100 in your checking account.

You purchase something for $120, and the bank accepts the charge. Your account balance will now drop to -$20 since you had to pay $120 from a balance of $100. This means you’ve overdrawn your account.

Accounts can be overdrawn in several ways, which can make them dangerous. Fortunately, there are things you can do to protect yourself from these fees, including regularly monitoring your checking account. I’ll share more ways to reduce overdraft fees later in this post.

How is it possible to overdraft a bank account?

You can overdraw your account in any of these ways:

  • Write a check for an amount that’s higher than what is available in your account balance.
  • Make a debit card transaction for an amount higher than what is available in your account balance.
  • Make an ATM withdrawal for more money than what is available in your account balance.
  • Process an ACH, direct deposit, or debit card payment for an amount that’s higher than what is available in your account balance.

How is an overdraft fee different from an NSF fee?

NSFs (Non-Sufficient Funds) are different from overdrafts in one important way. While in overdraft, the payment goes through even if you don’t have enough available funds (and then you get billed an overdraft fee).

With NSF, the payment doesn’t through, but you get billed an NSF fee for trying to use your account when it has insufficient funds.

How much is an account overdraft fee?

In most cases, overdrawing your account incurs a fee. Some banks do offer no-fee overdrafts, but this is not always the case. Typically, an overdraft fee will set you back about $35.00. This is an average since some banks charge less and others charge more.

Most banks will also have a limit on how many overdraft fees are charged to your account. Most banks limit this to 5 a day. While that’s better than limitless fees, it still means that if you’re not careful, you can be charged $175 – or more, if your bank has a higher fee or limit.

Some banks also charge what is called a Sustained Overdraft Fee or Extended Overdraft Fee. This fee is charged when an overdrawn account stays in the negative for an extended period. This time changes from one bank to another but is typically around the 5-day mark. Some banks will charge this once, but others will charge it every five days or even every day until the balance is settled.

Many banks will withhold charging you the overdraft fee till the end of the business day, giving you some time to correct the negative balance. You will also find that many banks do not charge a fee if you overdraft by $5.00 or less.

What is Overdraft Protection?

As the name implies, overdraft protection is protection against overdraft charges. There are different overdraft protection, with many banks offering a selection of different protections.

In most cases, this protection is offered against a fee.

Free Overdraft Protection

There are also several types of free overdraft protection, and while helpful, you don’t need a free checking account to qualify. But just like you can eliminate most checking account fees, here’s how you can eliminate, or at least minimize overdraft fees.

1. Link Accounts

One of the overdraft protections that many banks offer is linking accounts. Essentially, you set up an automatic money transfer for the missing amount from a secondary account – typically your savings account or your money market account. This way, you can make sure that any purchases, transfers, or withdrawals are covered.

Whenever such a transfer is made from your linked savings, you will typically be charged much less than an NSF fee. You can reasonably expect to pay around $10 for such a transfer. Still steep, but not as much as a full-blown overdraft fee.

Even so, it’s best to be careful. Linking accounts is not a fail-safe mechanism that you can set up once and forget about it. You will need to make sure there is enough money in your linked account to cover the difference, as otherwise, you might end up paying both fees.

One other thing that you need to be aware of is Regulation D. Although it was officially discontinued in April of 2020, Regulation D limited the number of withdrawals from a savings account to 6 per month.

Although the Federal Reserve has deleted the rule, many banks still apply this withdrawal limit, which in most cases stands at 6 per month. You can verify this by looking at your account agreement.

This means that by using your savings account to transfer fees instead of overdrawing your checking account, you are eating away at that limit. An extra transaction may see you being charged fees or seeing the savings account closed or switched to checking.

2. Lines of Credit

In principle, an overdraft line of credit works the same way as linking a savings account with one major difference. Instead of taking the money from a secondary account, the bank provides you with a line of credit to cover the difference.

You can expect to be charged a fee as well as interest on the borrowed amount. Of course, the line of credit isn’t limitless, and in most cases, you need to be approved by the bank before being given a line of credit to cover overdrafts.

Some banks also offer a cash advance, which works in the same way. Several online banks offer this service for free, with no additional fees or interest rate adjustments. Credit approval might be required.

3. Account Alerts

Email alerts are one of the simplest protections available when it comes to overdrafts. Most banks offer these for free and can be set up by yourself through the mobile banking app.

By allowing you to set up the alerts yourself, the bank is essentially allowing you to tailor them to your financial needs and requirements, helping you make sure they are valid and useful.

With account alerts, you will receive a notification on your phone every time your account hits a threshold. For example, you can configure account alerts to send you an alert on your phone when your balance drops below $100.

This can help you know if your account is running dangerously low on funds giving you time to transfer funds.

Do all banks offer overdraft protection?

Most banks offer overdraft protection. It’s important to note that different banks may offer different kinds of protection while others offer no protection.

Today, there are over 5,100 banks in the United States, with mergers, acquisitions, closures, and openings happening frequently. This makes it impossible to cover every bank.

Most banks list any overdraft protections they offer on their website, so it’s always good to check there first. You might also want to check your online banking or mobile banking app. Alternatively, you may give your bank or credit union a call.

How Do I Get Overdraft Protection?

In most cases, overdraft protection is opt-in, meaning you need to specifically ask the bank to include you in their overdraft protection program. Some protections, such as lines of credit, require approval and may be denied in some situations.

Most banks offer the facility of adding overdraft protection through their online banking or mobile banking app. You can also visit your nearest branch or give the bank a call.

Frequently Asked Questions

Is overdraft protection a good idea?

Overdraft protection can save you from unexpected charges when you don’t have sufficient funds in your account – so it’s often a good idea for your primary bank account. It provides overdraft coverage that protects you from fees when you have a negative balance. Overdraft protection is not free but will cost less than an overdraft fee. There are many different protections available, including linking an account. Here you need to remember to maintain a sufficient balance to cover the balance of the transaction.

Does overdraft protection hurt your credit?

Overdraft protection will not hurt your credit as long as you pay the charges on time and don’t ignore them.

Can you overdraft if you have no money?

Overdrafts happen when you don’t have enough money in your account to cover a transaction. The missing balance (what you pay – the balance you have) is covered by the bank, which in turn charges you an overdraft fee. This is different from NSF. Here the bank will decline the charge and then charge you an NSF fee.

How do you use overdraft protection?

Overdraft protection can be a great option when the available balance is not enough to cover the transaction. It’s an opt-in service, which means you need to contact the bank to subscribe. Once set up, overdraft protection works automatically, depending on the type of protection that you get. If you choose to link another account, keep in mind that you will still need to make sure that you have enough money and do not go over the allowed number of transactions.

If you get a line of credit, on the other hand, you’ll need to make sure you pay the balance since interest is usually charged.

How can I avoid overdraft fees?

There are several different ways through which you can avoid overdrafts. Knowing and understanding these can help you avoid paying a lot of fees, which, as we saw, can be quite high.

Many banks offer a threshold before they charge you an overdraft fee. Usually, it’s very low, around $5.00. Some banks will also allow you to transfer the amount of the overdraft before charging you a fee. Usually, this is set at the end of the day, but it depends on the bank’s cut-off time.

Ultimately, however, the best way to avoid overdraft fees is through careful planning and budgeting. If you’re an impulse buyer, make sure you have enough of a cushion to cover those random transactions (but better still, just avoid unplanned purchases if they’re not an emergency or a necessity).

Overdraft protection is worth considering

Getting hit with an overdraft fee in your account can be a painful experience, as many bank account holders will know. That’s where overdraft protection comes in.

There are so many ways to protect yourself from overdraft fees. We recommend combining a few of those ways to make sure you’re not wasting money paying any unnecessary fees.

If you’re not sure how much money you have in your account, pay with your credit card, or take thirty seconds to figure out your balance before making a purchase. It could save you a lot of money and headaches.