Overdraft Protection: What to Know & How to Avoid Fees

By Melanie Lockert

Have you ever swiped your debit card and held your breath, hoping you have enough money in your account? If so, signing up for overdraft protection seems like a natural solution. 

On the surface, overdraft protection seems like the perfect solution, but the details and reality of the optional banking services leave many banking customers wondering if it’s actually worth it. 

Explore our handy guide to learn all about overdraft protection, and overdraft fees, and how you can clean up your finances to avoid them altogether.

What is Overdraft Protection?

Overdraft protection is a safety net that helps you avoid overdrawing your account. Generally, if you make a purchase with your debit card and don’t have enough funds in your checking account, the purchase won’t go through. 

This is typically called an overdraft — and signifies that your account balance has dipped below zero and into negative territory. 

This situation can be embarrassing for you, as well as awkward for the person behind the cash register. It also can be highly inconvenient if you need whatever you’re purchasing now.

This is where overdraft protection comes in. Overdraft protection essentially protects you from overdrafting. So, instead of getting your card declined and leading to an uncomfortable situation, your card will go through like normal – even if you don’t have enough money in your account to cover that purchase.

How Does Overdraft Protection Work?

Overdraft protection is a type of financial protection that will help float you money if you have insufficient funds. So if you swipe your debit card or try to get cash out of an ATM, you may be able to do so even if you technically don’t have enough money in your account. 

It does this by pulling in money or credit from the account that you linked to your checking account when you set up overdraft protection with your bank.

But overdraft protection comes at a cost. Namely, in the form of overdraft protection transfer fees which can add up quickly. So, while overdraft protection, on the surface, can seem like a great solution to a temporary problem, it’s not always all it’s cracked up to be.

If you are interested in this protection, you’ll want to talk to your bank and enroll in the program. Additionally, it’s important to know all the upfront costs such as overdraft fees, credit line limits, etc.

Pros & Cons of Overdraft Protection

Before opting for overdraft protection, review the pros and cons first. 

Pros:

  • Convenience, as your purchase will go through. 
  • Save you embarrassment and time getting card declined in public.
  • Being able to access cash when you really need it.

Cons:

  • Paying overdraft fees. 
  • Interest if using overdraft line of credit. 
  • Pay for more than one charge, which adds up quickly. 

The overdraft fees can vary from bank to bank and your financial institution decides what to charge, and you’re usually hit with more than one charge.

You can continue getting hit with overdraft fees if your account is overdrawn for an extended period of time. These new fees are called extended overdraft fees and some are charged daily.

Consumers who frequently overdraft end up paying more fees than those who do not opt into overdraft protection. 

In fact, The Consumer Financial Protection Bureau (CFPB) found that frequent overdrafters who opt into this coverage pay nearly $450 more in fees.

On top of that, if you accrue enough overdraft fees and stay in the negative, you’re at risk of account closure. Having your account closed by your bank is a major inconvenience. Just think about all the bills that are connected to that account, or not having access to your money for a period of time.

All of these are major downsides of overdraft protection and should be considered carefully.

How Do You Use Overdraft Protection?

If you want to use overdraft protection, first make sure it’s something you’re signed up for. Your bank must get consent from you first to enroll you in overdraft protection.

Once you are enrolled, see if you have to link another account or a credit card to complete the process. Each bank may have different policies and procedures.

When it’s set up, overdraft protection will be in place if you overdraw your account. 

But remember: The hope is that you never have to use it! If you do, this means you’ve run out of money in your account, which is no fun and can be super stressful. That’s why it’s so important to keep tabs on where your money is going — both in and out, every day. 

Overdraft Fees Are Costing Americans Big Time

As noted above, in some cases your bank may offer you a line of credit or link your overdraft protection to a credit card. If linked to a credit card, you could end up paying more. Why? Because some card issuers might consider the overdraft a form of “cash advance,” which has its own set of fees, not to mention higher interest rates.

Overdraft fees – by and large – are a big business for many banks. Let’s look at the numbers:

  • Average overdraft fee: $35. 
  • Amount collected by big banks in overdraft fees in 2019: $11 billion dollars. 
  • Total amount collected in overdraft fees by financial companies in 2019: $34.6 billion. (source: CNBC)

Even credit unions, which are often thought of as more community-minded and consumer-friendly have jumped on the overdraft fee bandwagon. Overdraft fees at credit unions have nearly doubled from $15 in 2000 to $29 in 2017.

In short, overdraft fees are the bread and butter for many financial institutions. They give banks a way to make money off consumers by positioning overdraft protection as a useful service.

Currently, there is some pushback against overdraft fees during the coronavirus pandemic and a proposed bill that would put them on hold until the crisis is over. Some banks have eased up on overdraft fees but the issue is far from over. 

One pro tip is to check out Recoup, a service that helps get bank and credit card fees refunded and back in your pocket. 

How Do You Avoid Overdraft Protection?

Before 2010, many consumers were unaware that they were being “opted in” to overdraft protection programs. However, starting in 2010, federal regulations shifted and required that banks get consumers’ consent to opt into overdraft protection.

To make things simple, however, you can avoid overdraft protection by not signing up for it with your bank. If you’re currently enrolled in this service, you can cancel it. This way, if you don’t have enough in your account, your purchase or transaction will get declined. While you won’t be able to make the purchase, you also won’t be hit you with an overdraft fee.

Another option is to open a bank account at Chime, which has no overdraft fees.

Lastly, to avoid this problem altogether, keep a buffer of money in your checking account. This can help you avoid dipping into the negative. Check your account balances daily and monitor your bill due dates and auto-drafts. This way you’ll know when money is coming out of your account.

Final word

There are certainly pros and cons with overdraft protection.

It can be convenient, sure, but yet it is also costly. It can save you embarrassment and time, but also take a bite out of your hard-earned money. So, weigh these pros and cons carefully.

Final tip: If you never want to worry about an overdraft fee again, consider switching to a bank account that offers fee-free overdraft.

Melanie Lockert is the founder of the blog and author of the book, Dear Debt. Her work has appeared on Business Insider, Time, Huffington Post and more. She is also the co-founder of the Lola Retreat, which helps bold women face their fears, own their dreams and figure out a plan to be in control of their finances.

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