Overdraft Protection: Pros and Cons

Is overdraft protection worth having?

Checks and other debit transactions clear when you sign up for overdraft protection, even if your account lacks sufficient funds. In exchange for this service, your bank may charge hefty overdraft fees. Is this protection worth having? Here is a look at the pros and cons.

Key Takeaways

  • Overdraft protection ensures transactions still process even if there isn't enough money in your bank account.
  • This protection usually covers checks, ATM transactions, and debit card transactions.
  • Overdraft protection may make more financial sense, will result in the recipient not knowing your low bank balance, and ensures emergency transactions process.
  • However, you often have to pay for the service, may still have to pay uncovered fees, may still have your transaction declined, and may feel tempted to overspend.
  • Be sure to read the fine print before signing up for overdraft protection, as fees and terms vary from one bank to another.

How Overdraft Protection Works

Consumer banks used to automatically add overdraft protection to all checking accounts, but now this is a feature you must opt into or formally accept. Overdraft protection is utilized when there are insufficient funds in your account. Alternatively, you may have enough money in your account, but funds may be on hold not yet available for spending.

When the bank approves a debit purchase greater than your account balance, your account is overdrawn. There are often two outcomes. First, the bank automatically transfer funds between your accounts if sufficient funds exist in an associated account. Second, the bank may choose to pay for the transaction on your behalf, creating an obligation between you and the bank. In both situations, as the bank as additional processing for the transaction, they may choose to charge an overdraft fee.

Overdraft Fee vs. Non-Sufficient Funds Fee

An overdraft fee (or overdraft protection) only applies to one-time debit and ATM transactions. If the bank decides to allow the transaction that will cause your account balance to be negative, it assesses an overdraft fee.

If the bank rejects the transaction and chooses not to pay for it on your behalf, there are several different outcomes. First, your card may be declined. You won't be charged a fee, but your transaction won't process. Second, non-electronic charges like checks may incur a non-sufficient funds (NSF) fee. The check won't be processed, but you will incur a penalty that is similar to an overdraft fee.

The party receiving the bad check can demand reimbursement for the returned check fee and report you to ChexSystems. This repository is similar to a credit report for your banking history and may result in unfavorable lending terms or refusal of service in the future.

Pros of Overdraft Protection

When you sign up for overdraft protection, your bank will use a linked backup source that you designate—a savings account, credit card, or line of credit—to pay for transactions whenever the checking account lacks the needed funds. Here's several benefits of overdraft protection.

  • Your transaction will happen. Whether it's an emergency payment or simple mistake, the AM will give you cash, the debit card transaction will process, or the check will clear.
  • The recipient will not know. This is especially important in situations where your financial situation is of concern to the receiving party. An example is a business partner not being notified of your personal bank account funds being low or a landlord not knowing a tenant's financial situation.
  • You avoid overdraft fees. If you're unaware of your bank balance, you may be charged multiple overdraft charges in a single day.
  • You typically pay less. Overdraft coverage is a periodic charge auto-debited from your account. This service often costs less than paying an overdraft fee.
  • You have access to funds in an emergency. Even if your bank account is insufficient to cover a transaction, you are covered in the case of an emergency.

The simplest and least expensive way of having overdraft protection is to link your checking account to your savings account, thus covering your overdraft with your own funds.

Cons of Overdraft Protection

There are several drawbacks to overdraft protection. The service is not free, and there are implications if the service is abused.

  • You pay fees even if you don't overdraw. Like insurance, the coverage is there if you need it. However, if you manage your bank account balance and never overdraw, you're paying for this service just to never use it.
  • You may still pay overdraft fees. Some banks limit the coverage or assess a fee if multiple overdraft transactions have occurred. Ensure you understand your bank's coverage before agreeing to the protection.
  • Your transaction may still be declined. If you don't have enough funds in other linked accounts, your transaction may fail to be processed.
  • You may be tempted to overspend. Just because you have overdraft protection doesn't mean it's an advisable practice. You still need to manage your bank account, budget your spending, and know your limits.
  • Your bank may revoke services. If the overdraft protection service is abused, a bank may revoke membership status, especially if your bank account remains negative for too long.

Overdraft Protection

  • Your transaction will likely go through.

  • The recipient is not notified of the close call.

  • You often avoid overdraft fees and other penalties.

  • The annual cost may be less than a single overdraft fee.

  • Emergency transactions often still go through.

  • This service often comes with a charge.

  • You may still have to pay fees.

  • Your transaction may still fail.

  • It's often easier to overspend.

  • Your banking relationship may suffer.

What Happens When You Don't Have Overdraft Protection

Every bank will assess their own overdraft fee and charge different rates for overdraft protection. If you are making a small purchase, it's often advised not to write a check or use your debit card if you’re unsure whether your funds will cover the purchase. It is common for a transaction smaller than the overdraft fee to result in a penalty larger than the failed transaction itself.

Terms and conditions for overdraft fees vary significantly from one bank to another. If your bank’s overdraft fees are high, you may find it less expensive to pay using a credit card. This is different from linking your overdraft protection directly to a credit card, which can be pricey, because the credit card treats the linked transaction as a cash advance with a high interest rate and no grace period.

Average Overdraft Fee

Though overdraft fees will vary between institutions, many lenders currently charge $35 for an overdraft. The general range of overdraft fees is usually between $10 and $40.

Other Ways to Avoid Overdraft Fees

While it may be worth opting in if you don’t want transactions to be declined, a better choice is to sign up for email or text alerts to flag low checking account balances. You can often create alerts for specific bank balances or receive bank statements periodically. These alerts will give you an opportunity to 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 the balance is low.

What Are Overdraft Fees?

Overdraft fees are a penalty assessed by a bank for a transaction that exceeds the remaining balance in your account. You can avoid the fee by having overdraft protection through the bank, though there are some downsides to having the protection.

How Much Is an Overdraft Fee?

Each bank can set their own overdraft fees. Most lenders current assess a $35 overdraft fee per failed transaction, and the transaction can accumulate per day and per attempt.

Do I Need Overdraft Protection?

Some consumers appreciate the additional protection of knowing their transactions will go through and they will likely not be charged penalties for small mistakes. Other consumers may feel on top of their finances and not want to pay for additional services they will likely never use.

The Bottom Line

You may want peace of mind, or you may feel it's not necessary. If you're more on top of your finances or are not worried about overdrawing your account, overdraft protection may not be for you. However, if you want that service from the bank and need to know your transactions will go through even in the case of an emergency, ask your bank about their overdraft protection.

Article Sources
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  1. Consumer Financial Protection Bureau. "Understanding the Overdraft 'Opt-in' Choice."

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