Overdraft Protection: What It Is and Different Types

Overdraft fees can be a major drain on your finances. Some banks charge more than $30 per overdraft and potentially charge that fee multiple times per day if you keep making transactions that overdraw your checking account. If you want to avoid these fees, you can typically opt out of overdraft coverage with your bank. It can be useful, however, to set up overdraft protection instead of opting out so you don't find yourself unable to pay for something urgent.

What is overdraft protection?

Overdraft protection is a checking account feature that some banks offer as a way to avoid overdraft fees. There are several types of overdraft protection, including overdraft protection transfers, overdraft lines of credit and grace periods to bring your account out of a negative balance. Some other overdraft coverage programs might be a combination of these features.

Before you opt out of overdraft protection — which means your bank will decline any transaction that would result in an overdraft — consider how you might need overdraft coverage in an emergency. For example, let's say you’re using your debit card to pay for gas on a road trip. You need enough fuel to get home but don’t have enough money in your checking account. Instead of dealing with running out of gas, you may want to deal with an overdraft.

» Looking for good overdraft policies? Check out the best banks for overdrafts

How does overdraft protection work?

Here are more details about the main types of overdraft protection that banks tend to provide.

Overdraft protection transfers. When a bank allows you to make an overdraft protection transfer, you can link from a savings account, money market account or a second checking account at the same bank to your main checking account. If you overdraft your checking, your bank will take the needed funds from your linked account to cover the cost of the transaction. Many banks allow this service for free, but some banks charge a fee.

Overdraft lines of credit. An overdraft line of credit functions like a credit card — but without the card. If you don’t have enough money in your account to cover a transaction, your bank will tap your overdraft line of credit to cover the remainder of the transaction. Lines of credit often come with steep annual interest rates that are broken up into smaller monthly interest charges that you keep paying until the overdraft is paid back. A line of credit could end up being expensive if you use this option to cover your overdrafts.

Grace periods. Some financial institutions offer grace periods, so instead of immediately charging an overdraft fee, it will give you some time — typically a day or two — to return to a positive account balance after overdrafting. If you don’t do so within that time frame, your bank will charge you fees on any transactions that overdrafted your account.

Other coverage programs. Some financial institutions are taking a new approach to overdraft protection by offering what’s basically a free line of credit with a longer grace period for customers to bring their account to a positive balance. Varo Bank, Current and One all offer this kind of overdraft buffer. Another example, Chime’s SpotMe® program, allows customers to overdraft up to $200 with no fees. The customer’s next deposit is applied to their negative balance, and once the negative balance is repaid, customers can give Chime an optional tip to help keep the service "free."

4 ways to avoid overdraft fees

Overdrafts can happen to anyone. Here are some tips to help avoid overdraft fees.