Overdraft fees can seem inescapable. Top banks charge as much as $30 whenever you spend more money than is available in your checking account, unless you've opted into overdraft protection with a linked account or line of credit. Because banks generate substantial revenue from overdraft and non-sufficient fund (NSF) fees, it isn't a surprise they haven’t worked too hard to eliminate them.
Banks use a questionable process known as "reordering transactions" to maximize overdraft fees, processing the largest checks, ATM withdrawals and debit card transactions first, rather than in the order in which they are received. This triggers negative balances and overdraft fees more frequently. Here's how reordering can hurt you:
Say you have $100 in your account, with incoming charges of $25, $35 and $85 hitting the same day and in that order. You might expect the bank to process the charges in the order in which they arrive. The $100 would cover the $25 and $35 payments, but the remaining $40 balance would be insufficient to process the $85 transaction, which then incurs a single overdraft fee. But if the bank reorders the transactions to process the $85 payment first, that leaves an insufficient balance of $15 with two smaller transactions remaining. Now the bank can levy two overdraft fees instead of one. Seem fair?
While it can be a challenge to avoid overdraft charges, 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 overdraft coverage, it means you can buy things with your debit card or withdraw from an ATM even if there are insufficient funds in your account. That can save embarrassment at the lunch counter but you'll incur a hefty overdraft fee—or run up interest if your bank offers an overdraft line of credit to cover charges until you pay them back.
A 2010 Federal Reserve rule prohibits banks from automatically enrolling customers in overdraft protection. Now, you must opt in to have your debit card purchases or ATM withdrawals covered by your bank. If you prefer a rejected debit card transaction over a hefty one-time fee, contact your bank and forego overdraft coverage. But be warned: even when you opt out, most banks will charge NSF fees that can equal overdraft fees.
2. Choose a Checking Account with No Overdraft Fees
Some banks pride themselves on offering checking accounts that eliminate overdraft fees altogether. In most cases, the bank will decline to cover the attempted charge or ATM withdrawal and will not charge an NSF fee either. There are tradeoffs. Most no-fee checking accounts don't accrue interest and the bank might have few, if any, brick-and-mortar branches. However, these drawbacks are outweighed by the elimination of onerous overdraft and NSF fees.
3. Keep Money in a Linked Account
Many banks allow you to link a checking account with another account so payments are covered with your own funds in the event you overdraw. In lieu of the bigger overdraft fee, you'll be hit with a smaller transfer fee ($10 to $15 is common). Some banks will let you link a credit card to your checking account to serve as a cushion for overdrafts. If you go that route, it will likely be treated as a cash advance, incurring an immediate interest charge on top of the transfer fee.
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 can transfer funds into your account or skip that impulsive purchase until your next paycheck. Most banks with online or mobile banking capabilities allow you to set up an email or text alert when your balance drops below a pre-defined threshold, say $200, for example. You can also set alerts for whenever a deposit or withdrawal posts to your account, so you know when your balance is in trouble.
Even better, sign up for a daily email that reports your current balance. It won't protect the account against reordering, but you'll have a clearer picture of your spending habits.
The Bottom Line
Overdraft fees can be an unnecessary strain on your pocketbook. Banks make billions of dollars per year from customers overdrawing their accounts, with those who can least afford the fees often getting hit the hardest. But with a little extra vigilance and the right checking account, you can be fee-free and make the most of your money. For more, see Pros and Cons of Overdraft Protection.