Overdraft Fees: The Basics

Spencer TierneyJun 28, 2016

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Understanding how bank overdraft fees work and what overdraft options are available can help you save money. Read on to learn what an overdraft fee is, how it may affect you, and your choices for overdraft coverage and protection.

What is an overdraft fee?

Overdraft fee definition: An overdraft fee is a charge you receive from your bank when you spend more money than you have available in your bank account, usually your checking account.

To prevent this, most banks offer some form of overdraft protection, which broadly is defined as any service that helps customers cover an overdraft, typically for a fee.

Are fees charged for every overdraft I make?

It’s possible, depending on your bank’s policy. When an overdraft occurs, banks have the discretion to choose to cover the cost of customer overdrafts that come from checks, automatic bill payments or any recurring transactions as part of their standard overdraft practices without your consent; but they can also charge a fee for that courtesy.

Types of overdraft coverage and protection

At most financial institutions, you have three choices when it comes dealing with an overdraft:

Overdraft coverage. Sometimes called "courtesy pay" or "overdraft privilege," overdraft coverage is the most expensive option. You give your bank permission to pay all ATM and one-time debit card transactions that drop your checking account balance below zero. This typically results in a fixed overdraft fee, at a median cost of $34 — and multiple overdraft fees can arise from one transaction. Many banks charge an "extended overdraft fee" if you leave a negative checking account balance unattended for several days. Worse still, if you aren’t aware that anything's wrong, you might keep making purchases or withdrawals — and every new one could mean a new overdraft fee. Most banks put limits on how many overdraft fees you can get in one day, but even one fee is expensive.

Your bank is also legally required to ask if you want ATM and one-time debit card transactions covered as part of an overdraft program. Saying “yes” usually isn’t a smart move. If you don't opt in, these types of transactions are simply declined at no charge to you.

Opting out of coverage. You can decide not to participate in an overdraft program. In that case, all ATM and one-time debit card transactions that exceed the funds in your account will be rejected, and you won’t pay an overdraft fee. For other types of transactions — such as when a restaurant runs the tip you added to the bill after your meal — you'll still typically face a nonsufficient funds fee, also called a returned item fee. This generally costs the same amount as an overdraft fee, but you’ll avoid getting hit with multiple bank fees from one transaction.

Overdraft protection transfer. Offered by some banks, this alternative, also called "overdraft protection," lets you link your checking account to another account, such as a savings account or a second checking account, to cover the funds you need for a transaction. Some banks even let you link to a credit card or a line of credit, though it’s important to realize that you may be charged interest on the amount you use. Banks typically charge a fee, such as $10 or $12, for such transfers, but that's much cheaper than what overdraft coverage can cost you. Plus, many banks charge this fee per day instead of per instance, so you’d only pay once a day even for several transactions.

What’s the best overdraft option for me?

Check your bank’s overdraft practices and understand what choices are available. You can stay opted out of overdraft coverage for ATM or one-time debit card transactions, or you can opt in if you know you won't overdraw that often. A better option might be to choose an alternative such as an overdraft protection transfer or a line of credit. You'll usually end up paying something — either a low fee for a transfer or interest on what's drawn from the line of credit — but you'll avoid steep overdraft coverage fees.

Overdraft services are meant for occasional use. If you find yourself repeatedly overdrawing your checking account, consider using a prepaid debit card.

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