Overdraft Protection

DEFINITION of 'Overdraft Protection'

Overdraft protection is a guarantee that a check, ATM, wire transfer or debit card transaction will clear if the account balance falls below zero. Banks charge a hefty overdraft fee for this service unless the account is linked to a line of credit or fund transfer through a savings account or credit card. This loan or transfer kicks in automatically when a customer with overdraft protection writes a check, makes a wire transfer, swipes a debit card, or asks an ATM for more money than the current 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. 

BREAKING DOWN 'Overdraft Protection'

Customers must opt into overdraft protection to avoid a non-sufficient funds (NSF) fee that can exceed $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. For example, a renter with overdraft protection and a linked account writes an $800 check to cover the monthly rent but the account only has $650. The bank charges a transfer fee of $15 for approving a debit transaction that exceeds available funds and the renter will now have a  balance of $650 - $15 = $635 and have to pay off $800 through the credit card or line of credit unless a saving account transfer was used to cover the transaction.

Overdraft protection comes at a price because customers without linked accounts will pay overdraft fees that can exceed $30. 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 is 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.

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, making this form of overdraft protection very expensive.

Overdraft protection is optional and not for everyone. 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 or other transaction declined if the transaction amount exceeds available funds and be forced to pay the NSF fee.