When you open a new checking account, you’ll have the option to sign up for overdraft protection. Bank representatives often tout the service as a way to avoid overdraft fees and ensure you don’t miss important payments, but this type of protection can come at a cost. To decide whether overdraft protection is right for you, brush up on the pros and cons and associated costs, and consider other available options.
What Is an Overdraft?
An overdraft occurs when you attempt to complete a transaction or withdrawal for an amount more than what is available in your bank account. One of two things will take place: The transaction will either be declined or it will go through and overdraft your account. If your bank declines the transaction, you may be charged a nonsufficient funds fee. If your bank lets the transaction go through, you may be charged an overdraft fee. If an account remains with a negative balance for an extended period, you may receive additional charges based on a bank’s fee schedule.
What Is Overdraft Protection and How Does It Work?
With overdraft protection in place, your transactions will still go through, and you will avoid paying exorbitant overdraft fees from your bank.
When setting up overdraft protection services, you link your checking account to either a savings account, a credit card or a line of credit. If you complete a transaction that makes your checking account go negative, your linked account will cover the difference.
Harrison Hinz, a financial advisor at First Pacific Financial, says it’s important to link a savings account, rather than a credit card or line of credit.
“I wouldn’t recommend linking a credit card to overdraft protection,” he says . “That’s because using a credit card as overdraft protection counts as a credit advance.”
You must opt in to overdraft protection services either online or at a bank branch.
How Much Does Overdraft Protection Cost?
Some banks may charge overdraft transfer fees each time you use the overdraft protection, a monthly rate for using overdraft protection services, or both. This should be a deterrent from making overdraft protection services part of your normal banking.
“I think the right purpose is that occasional ‘Oops, I didn’t get my deposit in on time, and the check went out,'” says J. Derieck Hodges, a fee-only financial planner and founder of Anchor Pointe Wealth Management. “They should just be backstops, not planning tools.” Relying on overdraft protection can cause poor financial planning and cause you to lose track of your spending patterns.
Most of the top national banks do not charge for their overdraft protection services on a standard checking account. You should read the consumer account fee agreement from your bank or check with a local branch about overdraft protection fees associated with your account type.
Overdraft transfer fees listed are for accounts linked to deposit accounts, not credit cards or lines of credit.
Pros and Cons of Overdraft Protection
Having overdraft protection is almost all upside, but there are still some things to consider before you opt in.
Pros
- Your transaction will still go through, even if you don’t have sufficient funds in your account.
- The protection is good for an emergency situation or the occasional clerical error.
- Most banks don’t charge for an overdraft transfer. Even banks that do will charge significantly less than an overdraft fee.
Cons
- Some banks may still charge fees for using overdraft protection.
- If your account is linked to a credit card, you will have to pay fees associated with cash advances, as well as any interest on the balance. If you use a line of credit, you will have to pay interest on the balance until it is paid off.
- A transaction can still be declined if you have insufficient funds in your linked account.
- Relying on overdraft protection can cause poor personal finance habits.
Overdraft Protection Alternatives
If you don’t want to opt in to overdraft protection services, you have a few different options:
- Set low-balance alerts. Most banks will send you a text or email if you hit a preset limit on your checking account. Use that reminder to transfer more money from another account.
- Use apps. The Dave app allows qualifying users to receive an advance of up to $500 with no interest or late fees through its ExtraCash account. Chime’s SpotMe service allows users to overdraft up to $200 in debit card purchases with no overdraft fees.
- Find an overdraft policy that works for you. Some banks are cutting overdraft fees completely, others are making it less expensive, and still others are instituting new grace period policies. Find a checking account that won’t cost you money.