How Does Overdraft Protection Work?

What it means to overdraft your account

An overdraft fee occurs when there isn’t enough money in your chequing account to cover a transaction — as in, you tried to spend more money than you actually have. This could happen when you use an ATM, make a debit purchase at a store, write a cheque, transfer money to a different account or pay a bill by pre-authorized payment.

This situation has two possible outcomes. If you have overdraft protection, your bank will allow the transaction to go through and will lend you enough to cover it. Your account will display this amount as a negative balance, like –$20, and you’ll be charged overdraft fees and interest. If you do not have overdraft protection, the transaction will be declined and your bank will likely charge you a non-sufficient funds fee (NSF).

NSF fee vs. overdraft fee

You’ll likely be charged an NSF or overdraft fee when you attempt to make a payment that is more than the current balance of your bank account. Which one you’ll pay depends on whether you have overdraft protection or not.

If you don’t have overdraft protection, you will likely be charged an NSF fee, which is typically between $40 and $50. An NSF is a single fee, but you’ll be charged every time you try to make a payment of more than your balance. On top of the NSF fee, you might also need to pay a late fee if your insufficient balance means you pay a bill past its due date.

If your account has overdraft protection, you’ll avoid the big NSF fees. Instead, you’ll pay an overdraft fee and overdraft interest. The fee amount depends on your bank, but typically there’s either a monthly fee for overdraft protection or a fee for going into overdraft, plus interest on the amount you’ve overdrawn.

» MORE: Common bank fees and charges to know (and avoid)

How overdraft protection works

Overdraft protection is a feature of some accounts that allows the bank to complete the transaction, even if your balance is insufficient. Because the transaction moves forward, overdraft protection allows you to avoid paying NSF fees and any late payment fees.

When you have overdraft protection, your financial institution essentially lends you the money you need to make the transaction, up to a certain amount. Your account will show a negative balance and you will pay interest on the overdrawn amount until you deposit enough money to bring your balance back to $0. The interest rate is similar to what you might pay on a credit card, about 19%-22% depending on your bank.

Some financial institutions may also offer the option to link your bank account to another financial product, like a line of credit, another bank account or even a credit card. When your chequing account doesn’t have enough money to cover a transaction, this type of overdraft protection draws funds from the other source.

Typically, there are two types of overdraft protection:

Make sure to read the fine print on your account so you know what fees you might pay for overdraft protection and what kind of protection is available.

While overdraft protection fees might seem small compared to larger NSF fees, they still add up over time. It’s in your best interest to always be aware of how much money you have in your bank account before making transactions. It’s a good idea to keep a “safety cushion” in your account to help you avoid overdraft scenarios altogether.