What are the pros and cons of overdraft protection?

By Amy Fontinelle AAA
A:

If you sign up for overdraft protection and link your checking account to your savings account, a credit card or an overdraft line of credit, the bank will use that linked backup source to fund transactions you initiate when you don’t have enough money in your checking account.

The good thing about overdraft protection is that if you don’t have enough money in your checking account, your check will clear or your debit card transaction will go through anyway. The downside is that the bank will charge you an overdraft fee to make the transfer, even though you’re using your own money to cover your checking account shortfall, and in the case of an overdraft line of credit, you’ll pay interest on the amount you borrow until you pay it back. In addition, if you don’t have enough overdraft protection available to cover the shortfall, your transactions still won’t clear.

In most situations, it might not be a big deal to have a transaction declined because you don’t have enough money in your account, but in an emergency situation, it’s nice to have a source of backup funds. However, if your backup funding source is tapped out as well, you still won’t be able to complete your transaction. What’s more, if you know you can’t rely on overdraft protection in an emergency, you can plan to carry extra cash or a credit card, just in case. Paying cash for emergencies is your least expensive option; using a credit card could be more or less expensive than overdraft protection, depending on the terms of each option.

The good news about overdraft protection is that since 2010, banks have been required to ask consumers to opt in to this service for debit card purchases and overdrafts at ATMs. That means you won’t incur overdraft fees on these types of transactions unless you’ve chosen to do so. However, you can still incur automatic overdraft fees on checks and for online and automatic bill payment services when you overdraw your account.

Without overdraft protection for checks and bill payments, your bank can still charge you a non-sufficient funds (NSF) fee that can be comparable to an overdraft fee if there isn’t enough money in your account to cover the check. In addition, the party you wrote the bad check to can charge you a returned check fee (also similar in amount to an overdraft fee), and they can report you to ChexSystems, which is like a credit report for your banking history. Too many negative reports to ChexSystems may result in parties refusing to accept your checks and banks refusing to let you open an account or closing your existing account.

Overdraft fees typically cost $10 to $35 per item; Bankrate says the average overdraft fee was $32.20 in 2013. These fees can add up quickly if you make several transactions before you realize your account is in the red, and they aren’t worth it if you’re making a small purchase or if you have another source of funds.

Overdraft fees and terms and conditions vary significantly from one bank to another, so before you opt in, make sure to read the fine print. Some banks have low fees and limit the number of overdraft fees they will charge you per day. For example, Ally’s overdraft fee is $9 and won’t be charged more than once daily. Some banks don’t charge overdraft fees on small transactions; Chase waives the overdraft fee on charges of $5 or less. If your bank’s overdraft fees are high, you may find it less expensive to borrow money on a credit card. This is different than linking your overdraft protection directly to a credit card, which can be pricey if the credit card treats the transaction as a cash advance with a high interest rate and no grace period.

If you find it so embarrassing to have a transaction declined that you’re willing to pay an overdraft fee, it might be worth opting in, but a better choice is to sign up to receive email or text alerts from your bank when your checking account balance is low so you can avoid incurring overdraft fees at all. Instead, you can add funds to your checking account, wait to make a purchase or use an alternate form of payment.

You can also avoid overdraft charges with some banks’ free overdraft transfer services, which will automatically transfer money in preset increments (such as $100) from a linked savings account into your checking account when your balance is low.

RELATED FAQS

  1. Can 529 plans be used to transfer wealth to other family members if the original ...

    Yes, the 529 plan (also known as a "qualified tuition program") allows you to distribute and roll over funds from one 529 ...
  2. What does the Daily Average Revenue Trade (DART) tell me about a brokerage?

    A decline in a brokerage firm’s DARTs is not necessarily a cause for alarm, but you need to understand the factors behind ...
  3. Will having several credit cards hurt my credit score?

    The manner in which you use your credit cards may affect your credit score more than the number of credit cards you own will.
  4. What's a better way to borrow money: overdraft or credit cards?

    Overdraft and credit cards will allow you to spend more money than you have, but whichever option you choose, be sure to ...
RELATED TERMS
  1. Credit Card Authorized User

    Definition of an authorized user of a credit card.
  2. Gold IRA

    Definition of Gold IRA
  3. EMV

    A standard relating to integrated circuit cards, point-of-sale ...
  4. Integrated Circuit Card

    A card that has an embedded circuit, such as a computer chip. ...
  5. Gray Charges

    Fees consumers pay via credit card or debit card for unwanted ...
  6. Credit Card Teaser Rate

    A lower-than-normal interest rate that a credit card company ...
comments powered by Disqus
Related Articles
  1. How Wells Fargo Became The Biggest Bank ...
    Stock Analysis

    How Wells Fargo Became The Biggest Bank ...

  2. Comparing Credit Card Companies
    Credit & Loans

    Comparing Credit Card Companies

  3. Credit Card Or Cash?
    Credit & Loans

    Credit Card Or Cash?

  4. To Invest Or To Reduce Debt, That's ...
    Investing

    To Invest Or To Reduce Debt, That's ...

  5. Credit Card Arbitrage: Free Money Or ...
    Credit & Loans

    Credit Card Arbitrage: Free Money Or ...

Trading Center