It avoids embarrassment trying to spend money you don’t have, but it has its own cost.
Try to spend more money than you currently have in yours checking account is called an overdraft.
When this happens, your bank will usually refuse the transaction and may charge you an Insufficient Funds Fee (NSF). But that’s embarrassing and could get you into a bind if you need money fast – if your car breaks down, for example, and you have to pay to tow it.
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There is a solution. It’s called overdraft protection. If you sign up for it, your bank will allow your transactions even if you don’t have enough money in your account. But this strategy also has its price and can add up quickly.
This is how overdraft protection works
Banks used to automatically register customers for overdraft protection, but the government banned the practice in 2010. Now you need to opt for overdraft protection.
There are a few options your bank may offer you, including the following:
- Linking an authorized savings account: When you overdraw your checking account, your bank will automatically transfer funds from a linked one saving account to cover the overdrawn amount. It may charge a fee.
- Linking a credit card: If your checking account does not have sufficient funds, your bank will Advance payment on your credit card to cover the transaction. There may be a fee and the cash advance will likely come at a higher interest rate than regular purchases. There can also be no grace period. Depending on your credit rating, your bank may not offer this option and may only allow you to link it to one of their own credit cards.
- Overdraft protection for one-time transactions: Your bank will allow your transactions even if you do not have sufficient funds, but they will charge you a fee every time you do so.
- Overdraft line: Your bank will assign you a line of credit that is only used for overdrafts and is based on your credit rating. If you do need to resort to it, the bank will pay for your transaction, but interest will be paid on the overdraft and associated fees similar to a credit card until you pay it back.
All of these strategies ensure that even if you don’t have enough money in your checking account, your transactions will get through, but they all come with fees. More importantly, you pay these fees every time you overdraw your account. So if you make a few small purchases without realizing you’re overdrawn, you can pile up multiple overdraft fees before you know it.
And there are other limitations to overdraft protection that can affect its usefulness.
Limits to Overdraft Protection
Even with overdraft protection, your transaction may be declined. And depending on how often you’ve overdrawn your account or how long it has been overdrawn, additional fees may apply.
How much overdraft protection covers
When you link your savings account to your checking account, your overdraft protection is only as good as the money you save. If you try to withdraw more, the transaction may still be declined.
For example, let’s say you’re trying to make a purchase that costs $ 250. If your checking account is $ 50 and your linked savings account is $ 150, this is still not enough to cover the full cost of the purchase, so your bank will reject the transaction and you will be charged an NSF fee.
Anyone who links a credit card or chooses an overdraft facility can only top up up to their credit limit. If they exceed this amount, the transaction will be declined. If you choose overdraft protection for one-time purchases, your bank can set a flat rate in US dollars that you cannot exceed for overdraft fees.
How often can you overdraw an account?
Some banks may limit the number of overdrafts on an account per day or month, but there is usually no limit as long as you don’t exceed the credit limit or overdraft protection limit set by your bank.
When you link a savings account to your checking account to protect against overdrafts, keep the following in mind: Federal law limits you to six transfers or withdrawals per month. This includes any transfers or withdrawals that you make that have nothing to do with overdrafts. If you exceed this limit, a deposit withdrawal limit fee will apply in addition to your overdraft fee.
Some banks limit the number of overdraft fees they’ll charge you in a day, while others will charge you for every single transaction until you add more money to your account.
How long can your account be overdrawn?
Your bank should give you at least a few days to repay your debt before taking any further action. However, if your account has been overdrawn for several weeks, your bank may charge you an extended overdraft fee.
After a period of time, which may vary depending on the bank, your account will be closed and you will be reported to a debt collection agency. It will also send a negative report to ChexSystems. This is a credit reporting agency that tracks closed bank accounts, failed checks, and overdrafts. This could prevent you from opening a new checking account for at least five years.
Overdraft fees vary depending on the bank and the type of overdraft protection you choose.
When you link a credit card or savings account, the fees are lower – typically $ 10 to $ 12 per transaction. If you use a credit card, your card issuer will also charge you a cash advance. Those with overdraft protection for one-time purchases could pay $ 30 to $ 35 per transaction. And those with overdrafts can also pay a fee of $ 10 to $ 12 per transaction, and they have a balance with an APR of around 20%.
In contrast, the NSF fee you might incur without overdraft protection will be around $ 35 per transaction – after the transaction is declined.
The amount of overdraft fees you pay depends in part on how your bank arranges your transactions.
It can debit them from your account in the order in which you made the purchases. In this case, you’ll pay an overdraft fee for the first purchase that dropped your balance below zero and each subsequent purchase.
Or it can debit all of your purchases from largest to smallest in one day. In this case, regardless of when you bought it that day, the most expensive item will be charged first, and then the second most expensive item, and so on, until you get the cheapest item that you bought that day.
This strategy could result in much more overdraft fees. Consider the following scenario: Your bank account contains $ 200. You purchase a $ 5 item, a $ 10 item, a $ 25 item, and a $ 200 item before you discover your account is overdrawn.
If your bank had taken the chronological approach, you would only be paying an overdraft fee for that final purchase because you had enough money in your bank account to cover the three smaller purchases.
But if your bank charged your purchases in largest-to-smallest order, you wouldn’t pay an overdraft fee on the $ 200 purchase since your account has sufficient funds – but you would pay three separate overdraft fees for each of the three smaller purchases earlier made a day.
Is overdraft protection worthwhile?
Overdraft protection can be useful in certain circumstances, but it can also be costly, especially if you accumulate multiple overdraft fees in a single day. You can sign up for overdraft protection when you can rest assured that your transactions are unlikely to be declined even if you don’t have enough funds. However, make sure that you understand all of the terms first. Familiarize yourself with the restrictions and fees, and understand the method your bank uses to withdraw purchases from your account.
The best thing to do is to avoid overdrawing your account whenever possible. Try some of these tips:
- Monitor your spending. Keep track of your expenses Budgeting app or check your transaction history on your bank’s website or mobile app and avoid unnecessary spending when your balance is low.
- Sign up for account notifications. Many banks offer account notifications letting you know when your balance is low so you don’t accidentally overspend.
- Check your account balances. If you know you don’t have a lot of money in your account, check your balance before making a purchase to see if you have enough funds.
Overdraft protection is not inherently good or bad. It can either depend on your situation.
Knowing how it works can help you decide if it is right for you, but when in doubt, stay away and monitor your spending more closely so you don’t have to worry about needing overdraft protection.
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