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Overdraft Fees: The Basics

Banking, Checking Accounts
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Overdraft fees

Overdraft fees are among the most expensive bank fees you can pay, but they’re not inevitable. Understanding how they work and what overdraft options are available can help you avoid the worst of these fees.

What is an overdraft fee?

An overdraft is an amount of money you spend that goes beyond what you have available in a bank account, usually your checking account. This occurs when you withdraw or pay more than you have, whether it’s with a debit card, check or online transfer. To prevent this, banks offer overdraft protection, which broadly is defined as any service to let them cover such a transaction, typically for a fee.

When an overdraft occurs, banks can choose to cover checks, automatic bill payments or any recurring transactions as part of their standard overdraft practices without needing your consent. And they can charge a fee for that. However, your bank is 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, though.

» MORE: Overdraft coverage fees by bank

Overdraft options

At most financial institutions, you have three choices when it comes to overdrafts on your ATM withdrawals and one-time daily debit card purchases:

      1. Overdraft coverage. This program, sometimes called “courtesy pay” or “overdraft privilege,” 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 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.
      2. 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. You won’t pay an overdraft fee, but you typically will 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.
      3. Overdraft protection transfer. This alternative service, also called “overdraft protection,” lets you link your checking account to another account, such as a savings account or a second checking account. Some banks even let you link to a credit card or a line of credit. If your checking balance is too low to handle a transaction, your bank automatically transfers money from the linked account to your checking. Banks typically charge a fee, such as $10 or $12, for such transfers, but it’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.

Check your bank’s overdraft practices and understand your options. 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.

Spencer Tierney is a staff writer at NerdWallet, a personal finance website. Email: spencer@nerdwallet.com. Twitter: @SpencerNerd.