Overdraft Protection: What to Know & How to Avoid Fees

Have you ever swiped your debit card and worried that you might not have enough money in your account? If this sounds like you, you might consider overdraft protection to save you from such a predicament.

But is it worth it? Read on to learn all about overdraft protection and overdraft fees.

What is overdraft protection and how does it work?

In general, if you make a purchase with your debit card and don’t have enough funds in your account, the purchase won’t go through. This is typically called an overdraft — which is when you go below your account balance and dip into the negative territory. This situation can be awkward for you and the person behind the cash register. It also can be highly inconvenient if you need whatever you’re purchasing like now.

This is where overdraft protection comes in. Overdraft protection essentially protects you from overdrafting. So, instead of getting your card declined and leading to an uncomfortable situation, your card will go through like normal – even if you don’t have enough money in your account to cover that purchase.

But overdraft protection comes at a price, in the form of overdraft fees which can add up (more on that later). So, while overdraft protection, on the surface, can seem like a great solution to a temporary problem, it’s not all it’s cracked up to be.

So, what does overdraft protection do?

Overdraft protection is a safety net that helps you avoid overdrawing your account. In short, it’s a type of financial protection that will help float you money if you have insufficient funds. So if you swipe your debit card or try to get cash out of an ATM, you may be able to do so even if you technically don’t have enough money in your account.

If interested in this protection, you’d want to talk to your bank and enroll in the program. Additionally, it’s important to know all the upfront costs such as overdraft fees, credit line limits, etc.

Pros of overdraft protection

The main pro of overdraft protection is convenience. Overdraft protection allows purchases to go through, even if you don’t have enough funds in your account. This can save you embarrassment, inconvenience and time. You don’t have to deal with your card getting declined in public or being unable to access cash when you really need it.

How do I use my overdraft protection?

If you want to use overdraft protection, first make sure it’s something you’re signed up for. As noted above, your bank must get consent from you first to enroll you in overdraft protection.

Once you are enrolled, see if you have to link another account or a credit card to complete the process. Each bank may have different policies and procedures.

When it’s set up, overdraft protection will be in place if you overdraw your account. But remember: The hope is that you never have to use it! If you do, this means you’ve run out of money in your account, which is no fun.

Cons of overdraft protection

Overdraft protection seems good in theory but it can cost you in the long run. The fees can vary from bank to bank and your financial institution can decide what to charge. And it’s not just one charge either. You can continue getting hit with overdraft fees if your account is overdrawn.

We found that consumers can get hit with four to six overdraft fees per day. In some cases, that number can be as high as 12. What’s more: Consumers who frequently overdraft end up paying more fees than those who do not opt into overdraft protection. In fact, The Consumer Financial Protection Bureau (CFPB) found that frequent overdrafters who opt into this coverage pay nearly $450 more in fees.

On top of that, if you accrue enough overdraft fees and stay in the negative, you’re at risk of your account being closed. Having your account closed by your bank is more than just a pain, but a major inconvenience on your financial life. Just think about all the bills that are connected to that account, or not having access to your money for a period of time.

All of these are major cons of overdraft protection and should be considered carefully.

The reality of overdraft fees

Overdraft fees – by and large – are big business for many banks. In fact, the average overdraft fee is around $35. In 2017, consumers paid 34.3 billion dollars in overdraft fees in 2017, a number which has been on the rise since the Great Recession.

Even credit unions, which are often thought of as more community-minded and consumer friendly have jumped on the overdraft fee bandwagon. Overdraft fees at credit unions have nearly doubled from $15 in 2000 to $29 in 2017.

In short, overdraft fees are the bread and butter for many financial institutions. They give banks a way to make money off consumers by positioning overdraft protection as a useful service.

What does overdraft protection mean for your credit?

As noted above, in some cases your bank may offer you a line of credit or link your overdraft protection to a credit card. If linked to a credit card, you could end up paying more. Why? Because some card issuers might consider the overdraft a form of “cash advance,” which has its own set of fees, not to mention higher interest rates.

Can you overdraft if you have no money?

To get overdraft protection, your bank will typically connect a savings account and move over funds to cover the overdraft. If you don’t have any money in savings, the protection may not work.

However, other banks have overdraft lines of credit. If eligible, the bank will loan you a line of credit so that your purchases are covered, even if you don’t have enough money in your account. Of course, you will still have to pay it back, with interest, like any other line of credit.

Can you withdraw money from an ATM if you have a negative balance?

If you’re headed to the ATM to get cash, and end up taking out more than you have in your account, you will overdraft. The overdraft definition means that you “overdraw” on your account, which means taking more than you have available.

If you have overdraft protection, you will likely be able to withdraw money from your account and you’d have a negative balance.

But of course, there will be an overdraft fee attached. So while you may get the cash you need, if you don’t have the funds in your account, it will cost more in the long-run.

How can I avoid overdraft protection?

Before 2010, many consumers were unaware that they were being “opted in” to overdraft protection programs. However, starting in 2010, federal regulations shifted and required that banks get consumers’ consent to opt into overdraft protection.

To make things simple, however, you can avoid overdraft protection by not signing up for it with your bank. If you’re currently enrolled in this service, you can cancel it. This way, if you don’t have enough in your account, your purchase or transaction will get declined. While you won’t be able to make the purchase, you also won’t be hit you with an overdraft fee.

Another option is to open a bank account at Chime, which has no overdraft fees.

Lastly, to avoid this problem altogether, keep a buffer of money in your checking account. This can help you avoid dipping into the negative. Check your account balances daily and monitor your bill due dates and auto-drafts. This way you’ll know when money is coming out of your account.

Final word

There are certainly pros and cons with overdraft protection.

It can be convenient, yet costly. It can save you embarrassment and time, but also take a bite out of your hard-earned money. So, weigh these pros and cons carefully.

Final tip: If you never want to worry about an overdraft fee again, consider switching to a no-fee bank account.

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