How Overdraft Fees Work - And How to Avoid Them

Overdraft fees can seem inescapable. The top 50 retail banks charge a median fee of $34 whenever you spend or withdraw more money than is available in your checking account. Since 61% of banks’ revenue from consumer checking accounts comes from overdraft fees, according to the Consumer Financial Protection Bureau, financial institutions haven’t exactly been clamoring to eliminate them.

Last year, The New York Times revealed that many banks use a practice called "reordering," in which – instead of processing checks in the order they are received – they process the largest ones first. This allows them to maximize overdraft fees.

Here's how reordering can hurt you: You take $100 out of the bank and the ATM says you still have $62 left in your account. However, the bank decrees that you were actually overdrawing your account. How can the bank do this when the machine said you had funds? It reorders how it processes your checks: For example, it first charges against your account a big rent check that arrived after your withdrawal. This check eats up your $62 balance and leaves you overdrawn when your $100 withdrawal is processed.

While it can be a challenge to avoid those sudden extra charges on your bank statement, there are strategies for keeping your hard-earned money where it belongs: in your pocket.

1. Opt Out of Overdraft Coverage

When a bank offers you overdraft coverage, it means you’ll be able to make a purchase with your debit card or withdraw from an ATM even if you don’t have the full amount available in your account. That can save you embarrassment at the lunch counter, but you’ll incur an overdraft fee – or run up interest if your bank offers you an overdraft line of credit to cover the charge until you pay it back. 

A 2010 Federal Reserve rule prohibited banks from automatically providing overdraft coverage to their customers. Now, you must opt in to have your debit card purchases or ATM withdrawals covered by your bank, or they’ll be declined. If you prefer the possibility of a rejected debit card over a one-time fee, contact your bank and choose to forego overdraft coverage on your checking account. But be warned that even when you opt out, most banks will allow paper checks and automatic bill payments to go through. You’ll be spared the headache of a bounced check or an unpaid utility bill, but you’ll be charged a pesky overdraft fee on those transactions. 

2. Choose a Checking Account with No Overdraft Fees

If you don’t want the hassle of having to opt out of overdraft protection, switch to a checking account that prides itself on eliminating overdraft fees altogether. Mobile apps like Simple and Moven have a user-friendly online banking interface and budgeting tools, and several banks including Capital One and Bank of America offer fee-free checking options. In most cases, the bank will decline to cover the attempted charge or ATM withdrawal instead of collecting a fee. There are some tradeoffs: Most no-fee checking accounts don’t accrue interest and few offer the option to bank at brick-and-mortar branches.

3. Keep Money in a Linked Account

Many banks offer overdraft protection, or the option to link your checking account with another bank account so that any time you overdraw, the payment will be covered by your own funds. You’ll avoid the bigger overdraft fee, but often get charged a transfer fee ($10 is common). Some banks will also let you link your credit card to your checking account to serve as the cushion for overdrafts. But if you go that route, you’ll incur an interest charge on top of the transfer fee, unless you pay off your credit balance each month. 

4. Set Up Daily Account Balance Alerts

Knowledge is power when it comes to your bank account. If you know ahead of time that your balance is dangerously low, you’ll be able to transfer funds into your account or just skip over that impulse debit card purchase until your next paycheck comes through. Most banks with online or mobile banking capabilities will allow you to set up an email or text alert when your balance drops below a threshold – $200, for instance – that you define. You can also choose to get an alert whenever a deposit or withdrawal posts to your account so you know when your balance is in flux. Even better, opt for a daily email that shows your current balance. It won't protect you completely against "reordering," but you’ll have a clearer picture of how closely you should be eyeing your spending.

The Bottom Line

Overdraft fees can be an unnecessary strain on your pocketbook. Banks have been reported to make billions of dollars per year from customers overdrawing their accounts and ATM fees. Those who can least afford it are often hardest hit. Young adults, for instance, are almost four times more likely than people 62 and older to have 10 or more overdrafts a year. But with a little extra vigilance – and the right checking account – you can be fee-free and make the most of your money.