What Is Overdraft Protection?

Overdraft protection is an option offered in bank accounts that prevents check, ATM, or debit card transactions, as well as wire and electronic transfers, to cause a user's account balance from falling below zero thereby triggering of an overdraft or non-sufficient funds (NSF) fee.

Overdraft protection also allows non-preauthorized transactions made with a check and ACH withdrawals from being returned unpaid or bouncing. Most banks charge a hefty fee ($35 is the average) for accounts that are overdrafted or do not have sufficient funds.

Why Use Overdraft Protection?

Non-sufficient funds (or insufficient funds) transactions can be expensive and disruptive. If a bank receives a check written on an account with insufficient funds, the bank can refuse payment and charge the account holder an NSF fee. Additionally, a penalty or fee may be charged by the merchant for the returned check. If you bounce a check, for example, you can incur a variety of charges or see your bank close your account in extreme cases, hurting your chance of opening a new checking account.

Customers who opt in for overdraft protection can link their checking accounts to credit cards, savings accounts, or other lines of credit can avoid triggering an overdraft fee. This amounts to a pre-approved loan or transfer that kicks in automatically when a customer writes a check, makes a wire transfer, swipes a debit card, or asks an ATM for a sum of money in excess of an account's balance.

Overdraft protection, sometimes called cash reserve checking, is most frequently used as a cushion for checking accounts but can be applied to savings accounts as well. Banks have the right to reject loans or fund transfers if they fall outside the rules of the overdraft protection agreement.

As of July 2010, banks were forced to make overdraft protection an opt-in service for smaller transactions that are made at the ATM or via debit card. Consumers who opt into such programs may pay as much as seven times more in non-sufficient funds or overdraft fees, according to the Consumer Financial Protection Board (CFPB).

How Overdraft Protection Works

Customers must opt in to overdraft protection to avoid a non-sufficient funds fee or overdraft fee that typically exceeds $30 per transaction. Typically, an overdraft protection agreement kicks in when an account holder withdraws more than the current balance in a checking account. In that case, the individual or business with a linked account is charged a fee to facilitate a fund transfer. It is not uncommon for banks to charge multiple overdraft fees per day, such as when a consumer makes successive purchases.

Key Takeaways

  • Overdraft protection is a guarantee that a check, ATM, wire transfer, or debit card transaction will clear if the account balance falls below zero.
  • Bank customers can opt in or out of overdraft protection for their checking and savings accounts.
  • There may be heavy fees and interest associated with overdraft protection.
  • Overdraft protection lines of credit can range from $250 to $5,000 and above.

Overdraft protection comes at a price; customers without linked accounts will pay overdraft fees that average between $30 and $35. And like all loans, an overdraft protection line of credit has an interest rate attached to it.

In addition, many banks charge an extended overdraft fee if a checking account goes negative for more than a few days. It's important to note that, even if an account holder has overdraft protection, banks will still charge this additional fee. Overdraft protection lines of credit can range from $250 to $5,000 and above.

The account holder may be also be charged an additional fee every month that protection is used or a fixed monthly fee for continuous protection.

Example of Overdraft Protection

A renter with overdraft protection and a linked account writes an $800 check to cover their monthly rent but their account only has $650. Instead of bouncing the check due to insufficient funds, the renter's overdraft kicks when the check is cashed.

Then, the bank charges a transfer fee of $15 for approving a debit transaction that exceeds available funds. The renter will now have a balance of $650 - $15 = $635 and has to pay off $800 through their credit card or line of credit unless a saving account transfer was used to cover the transaction.

Special Considerations

As an alternative to a line of credit, many banks allow customers to link checking accounts to a credit card or savings account at the same bank. However, note that credit card transfers used to cover overdrafts are treated as cash advances. Cash advances against a credit card have no grace periods and incur high-interest rates, as well as cash advance fees (usually a $10 flat fee or 5% of the advance, whichever is greater), making this form of overdraft protection fairly expensive.

Bank customers can opt in or out of overdraft protection for their checking or savings accounts.

Customers opting out of overdraft coverage will have a check, online payment, or automatic recurring debit transaction declined if its amount exceeds available funds and be forced to pay the NSF fee.

Overdraft Protection Trends

As of 2017, the median overdraft fee was $34 among the 50 largest U.S. retail banks (by deposits) according to the CFPB. Smaller institutions and credit unions tend to charge less (a median of $31), and some banks, such as online banks, do not charge any overdraft fees. The most common overdraft fee is $35. Banks are unlikely to address overdraft fees, which many consider an abusive fee. As of mid-2018, while under Acting Director Mick Mulvaney, the CFPB halted its rulemaking plans to address such fees.