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.

  1. How does your checking account affect your credit score?

    Your credit report provides a snapshot for prospective lenders, landlords and employers of how you handle credit. For any ... Read Full Answer >>
  2. Can mutual funds outperform savings accounts?

    A mutual fund can – and should – outperform a savings account. In most cases, it should not even be a close race. Savings ... Read Full Answer >>
  3. Can I use my IRA savings to start my own savings?

    While there is no legal reason why you cannot withdraw funds from your IRA to start a traditional savings account, it is ... Read Full Answer >>
  4. How soon should I start saving for retirement?

    The best answer to the question, "How soon should I start saving for retirement?", is probably, "yesterday," and the second ... Read Full Answer >>
  5. Can I use my 401(k) as a collateral for a loan?

    Although federal Internal Revenue Service, or IRS, regulations prohibit using a 401(k) account as collateral for a loan, ... Read Full Answer >>
  6. How does a bank determine what my discretionary income is when making a loan decision?

    Discretionary income is the money left over from your gross income each month after taking out taxes and paying for necessities. ... Read Full Answer >>
Related Articles
  1. Credit & Loans

    Make Money Off Credit Card Sign-Up Bonuses

    It's easy to benefit from credit card sign-up bonuses, but you have to know what you're getting into.
  2. Credit & Loans

    Reasons You Should Use Your Credit Card For Purchases

    Paying for everything with your credit card will earn you rewards and protect you against fraud, among other benefits.
  3. Credit & Loans

    Explaining Equated Monthly Installments

    An equated monthly installment is a fixed payment a borrower makes to a lender on the same date of each month.
  4. Savings

    6 Millionaire Traits That You Can Adopt

    Millionaires have more in common than just their bank accounts. They share certain qualities that help them make it to the top.
  5. Investing

    10 New Apps That Help Budget For Expensive Cities

    From platforms for saving money to those that account for side jobs, mobile apps are changing spending habits and income generation in urban areas.
  6. Savings

    Best Ways to Send Large Sums of Money Abroad

    Understand why it may be difficult to send large sums of money internationally. Learn about the top five ways to send large sums of money abroad.
  7. Stock Analysis

    JP Morgan Chase & Co. Vs. Bank of America Stock

    Examine two of the big four U.S. money center banks, Bank of America Corporation and JPMorgan Chase & Company, by comparing important equity evaluation metrics.
  8. Investing

    How To Protect Your Retirement from Lawsuits

    Getting sued is one of those things that no one really plans on. Be proactive and make sure your hard-earned retirement is safe from lawsuits.
  9. Budgeting

    Top 7 Money Saving Tips for Eating Out

    Discover seven money-saving options available to consumers who are looking to partake in the luxury of dining out while cutting down on cost.
  10. Economics

    Explaining the Tier 1 Leverage Ratio

    The Tier 1 leverage ratio measures a bank’s core capital against its total assets.
  1. Overdraft Cap

    The maximum dollar limit that a bank will send to another financial ...
  2. Overdraft Protection

    A line of credit that banks offer to their customers to cover ...
  3. Overdraft

    An extension of credit from a lending institution when an account ...
  4. Bank Deposits

    Money placed into a banking institution for safekeeping. Bank ...
  5. Term Deposit

    A deposit held at a financial institution that has a fixed term, ...
  6. Cost Of Funds

    The interest rate paid by financial institutions for the funds ...

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!