What is Overdraft Protection, and How Does It Work?

If you’ve been wondering, “What does overdraft protection mean?” let’s break it down. Simply put, overdraft protection is an optional banking service that can cover transactions which exceed your available balance.

To use it, you link another account, such as a savings account, credit card or line of credit, to your checking account.¹ If your checking account balance goes into the negative, your bank will automatically transfer money from your linked account to cover the shortfall.

Without overdraft protection, your bank might still cover the difference – known as overdraft coverage – but would charge hefty overdraft fees, often $35 per transaction.² Alternatively, it might reject the transaction completely.

That’s not to say overdraft protection is always free – some banks charge a fee for this service. And if you’re using a credit card or line of credit to cover overdrafts, you may have to pay additional fees and interest on the transferred amount.

Overdraft protection automatically transfers money from a linked account to your checking account to cover a negative balance. Let’s say you have a balance of $80 in your account and swipe your debit card for $100. With overdraft protection, your bank would automatically transfer money from your linked account to cover the $20 gap.

There are a few options for what kind of account you can link, such as:

• Savings account: You can connect your savings to your checking to protect your account from overdrafts. If you go this route, you’ll need to have sufficient funds in your savings account to cover transactions.
• Credit card: If you link a credit card, any transfers will be considered a cash advance.³ Unlike typical credit card charges, cash advances start accruing interest right away.⁴ They might also come with a fee, so read the fine print before going this route.
• Line of credit: You can also link an established line of credit to your bank account for overdraft protection. Using a line of credit will also incur interest charges and potential fees.

Overdraft protection can have fees and interest charges. However, the costs may be lower than what you’d have to pay in overdraft fees if your bank were to cover the negative balance.

While overdraft protection can help you out in a financial squeeze, it also has some potential downsides. Consider both the pros and cons before you opt in.

Pros

Avoid overdraft coverage fees: Having overdraft protection means you don’t have to pay overdraft coverage fees if you overdraw your account.
Free in some circumstances: You may not have to pay any fees if you use a savings account for your linked account.
Won’t have transactions rejected: With overdraft protection in place, you won’t have to worry about declined transactions or bounced checks.

Cons

Could incur fees and interest charges: Some banks charge an overdraft protection fee each time you use it. Plus, you may have to pay fees and interest if you use a credit card or line of credit to cover overdrafts.
Still possible to have transactions rejected: If you link a savings account with insufficient funds, you could still see declined transactions.
Could lead to more overspending: Since you won’t see your purchases declined, overdraft protection might give you a false sense of financial security. This could lead to a cycle of overspending.

Overdraft protection and overdraft coverage sound similar, but they work in different ways. If you use overdraft protection, you’re covering a negative balance from your own funds, whether from a savings account, credit card or line of credit.

With overdraft coverage, on the other hand, your bank will spot you money if your account falls below $0. Banks may charge as much as $35 per transaction for this convenience.2 These fees can add up quickly if you overdraft multiple times.

Not all banks charge fees for overdraft coverage, though. With SpotMe, Chime spots you money fee-free when you overdraw your account by up to $200.

You’ll pay back the amount automatically the next time cash is deposited into your Chime checking or credit builder secured deposit account.

Overdraft protection can be a useful tool if your checking account tends to run low. Rather than borrowing from the bank to cover overdrafts on your checking account, you’ll borrow from your own savings account, credit card or line of credit. Before opting in, though, familiarize yourself with the costs of using this service.

You can also consider fee-free overdraft coverage, such as Chime’s SpotMe. By researching your options for overdraft coverage vs. overdraft protection, you can find the best way to manage your bank account and avoid costly overdrafts.

If you find yourself often going into the red, these 10 ways to stop spending money can help you get your budget back on track.