Hannah Logan
How does overdraft work?
An overdraft is when your chequing account balance dips below the value of $0 — as in, you tried to spend more money than you actually have. This could happen when you’re taking out cash at an ATM, making a debit purchase at a store, writing a cheque, making a bank transfer or paying a bill by pre-authorized payment.
This situation has two possible outcomes. If you have overdraft protection, your account will display a negative balance, like –$20, and you’ll be charged overdraft fees and interest. If your payment is rejected because of insufficient funds and you do not have overdraft protection, your bank will likely charge you a non-sufficient funds fee (NSF).
NSF fee vs. overdraft fee
You’ll likely be charged one of these fees when you attempt to make a payment that is more than the current balance of your bank account. Which one you’ll face 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 one-time fee, but you’ll be charged every time you try to make a payment that’s worth 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 a monthly fee for the protection and/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 does overdraft protection work?
Overdraft protection is an add-on for your bank account that allows you to cover the cost of a transaction, even if you don’t have enough money in your account. This helps you avoid paying NSF fees and any late payment fees.
Typically, there are two types of overdraft protection:
- Basic overdraft protection. The 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 make your balance positive. The interest rate is similar to what you might pay on a credit card, about 19-22%.
- Linking your bank account to another financial product. This could be a line of credit, another bank account with funds in it, or even a credit card. When your bank account doesn’t have enough money, this type of overdraft protection draws funds from the other source.
Both of these overdraft protection options come with fees. You may pay a monthly fee whether you need to use your overdraft protection or not. Alternatively, you may be charged a pay-per-use fee each time you require overdraft protection. These fees vary by financial institution but are often around $5 per month or per overdraft transaction. Make sure to read the fine print on your account so you know what fees you might pay for overdraft protection.
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.
» MORE: How to save money
FAQs
If you try to spend more money than you have in your account, you can go into overdraft. This is true whether your account has $1 or $100 in it. Your overdraft protection agreement includes a limit, which is the maximum amount that you can go into overdraft.
Overdraft protection itself isn’t bad for your credit. However, being in overdraft for too long could impact your credit score. For example, if you don’t pay back the overdraft by the deadline listed in your agreement, your bank account could default, which would hurt your credit score. If you do go into overdraft, get your balance back above $0 and pay off any fees as soon as possible to prevent any unintended effects on your credit.
Depending on your type of bank account, overdraft protection may be included, meaning that you won’t be charged an extra fee if your account goes into overdraft. This is more common with top-tier type chequing accounts rather than basic accounts. Another potential scenario is that if you went into overdraft for a small amount, like $5, your bank may not have charged you a fee as a one-time courtesy.
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