FAQ: What Is the Overdraft Protection Law and How Do Overdraft Fees Work?

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When customers attempt a debit card or ATM transaction but do not have enough money in their account, the bank can either process or reject the transaction. Overdraft protection rules help determine what happens, and if there are fees.

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The overdraft protection law stops banks from automatically enrolling customers in overdraft coverage. The coverage allows banks to process transactions when customers have insufficient funds. Banks usually charge a fee of around $35 for each of these transactions.

In 2010, the Federal Reserve declared that by default a bank must reject transactions if an account lacks sufficient funds. However, customers can choose to change the default status and opt in to overdraft coverage, if the bank offers the service. Transactions would be approved, but the bank could charge fees.

The law only applies to transactions that are not pre-authorized, such as ATM withdrawals and debit card transactions. Pre-authorized withdrawals, such as automatic bill payments and checks, do not fall under the umbrella of the overdraft protection law and can still lead to overdraft charges.

Overdraft protection is a common bank service that links a checking account with a line of credit, savings account or credit card. The bank processes an insufficient funds transaction and transfers funds from the linked account. The account would no longer be negative, so there would not be an overdraft fee.

A customer will need to have sufficient money in their savings account or qualify for a line of credit. Some banks don't charge a fee for this service, but other institutions charge a transfer fee — often around $10 — each day a transfer is made.

When it comes to overdrafts, customers generally have three choices:

Customers can avoid overdraft fees by choosing not to enroll in an overdraft program. Those who do opt in can lower costs by choosing a bank that allows free transfers from linked accounts. Another way to reduce fees is to choose an institution that limits the number of overdraft fees charged per day.

Here is NerdWallet's list of the best banks to avoid or reduce overdraft charges.

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Your bank may offer overdraft coverage for debit and ATM transactions, but you don't have to accept it. Overdraft protection rules let you decide the best option for your account.

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