What Is Overdraft Protection?

By John Boitnott
Reviewed by: Ana Gonzalez-Ribeiro, AFC®
Published on: 02/22/2022

Whether it’s a check you write for a service or purchase, or a debit card transaction that the bank approves even though you’re only a few dollars short, overdrafts happen, even to the most careful account holders. Sometimes it’s a math error that causes your account to lack the funds necessary for a transaction. Sometimes it’s an oversight that leads to an inaccurate assessment of available funds. Sometimes a deposit takes longer than anticipated, leaving your account short.

Whatever the cause, when your account doesn’t have sufficient funds to cover a transaction, your bank can assess some fairly exorbitant fees as a penalty, even when the shortfall is as insignificant as a few dollars. And if you can’t get that shortfall resolved—a shortfall that’s now much larger thanks to the additional fee—you may well incur additional charges when other transactions post to your account.

What’s more, the bank will likely decline to honor transactions when the account balance is so substantially in the negative, meaning you’ll have to also come up with additional funds to pay those obligations and any fees or penalties the other party to the transaction might assess.

Clearly, overdrawing your account is something to avoid if at all possible. One of the simplest ways to do this is to enlist in your bank’s overdraft protection program.

What is overdraft protection?

When the amount of the transaction being presented against your account—say, for example, a check for rent or a debit card purchase—is greater than the funds that are available in that account, the difference is called an overdraft, or “being overdrawn.” And when an overdraft occurs, your bank can take one of two actions:

  1. Honor the transaction, covering the overdraft either itself or through overdraft protection, and assess an overdraft fee; or
  2. Decline to honor the transaction and assess a non-sufficient funds (NSF) fee.

In both cases, the amount of the fee is about or exactly the same, depending on your financial institution’s schedule of fees. Currently, the average overdraft fee ranges between $30 and $35 per overdraft event. The major difference is how the original transaction is treated, but in either case you’ll need to eventually pay back the overdraft as well as the fee. However, many account holders feel that it’s better not to have to cover a returned check or declined debit transaction on top of the fees. That’s why overdraft protection plans are increasingly popular.

How does overdraft protection work?

When you enter into an overdraft protection program with your bank, credit union, or other financial institution, you’re adding a specific service that lets your bank cover any overdrafts in your checking account, up to a certain set limit. Sometimes the bank will offer the service free of charge, such as Bank of America’s Balance Connect overdraft protection program. In other cases, you can expect to pay a fee, which is established by your bank. The fee is typically lower than the amount of the bank’s overdraft fee.

If your overdraft protection program is linked to a second account in your name, such as a savings account, you’ll be limited to coverage in the amount of your balance in that account. The bank may also impose a maximum amount for coverage per day, regardless of the balance in your other account.

Finally, it’s important to remember that a bank’s overdraft protection program terms and conditions will generally give the bank the discretion to decline to cover a specific transaction, even if it would otherwise be eligible for coverage.

How do you avoid overdraft fees?

In addition to enlisting in your bank’s overdraft protection program, you can avoid the imposition of costly overdraft fees with a few straightforward financial strategies:

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  1. Keep your account balanced: Balancing your checking account regularly is the only way to know precisely how much money you have in it and which transactions haven’t yet been posted. This is the most effective way to prevent accidental overdrafts due to math errors.
  2. Use cash for purchases whenever possible: You can’t overdraft your account if you don’t create transactions to be debited from it. Take out cash from your account to cover weekly budgeted items. Just make sure you keep good receipts for cash purchases.
  3. Keep a buffer in your account: Adding a buffer or cushion amount to your checking account will also help you avoid accidental overdrafts. The key is acting as if that buffer is not there.
  4. Have your paycheck deposited directly: Life sometimes gets in the way of our best laid plans and most reasonable expectations. A direct deposit agreement with your employer will help ensure your wages are there in your account when you need them.
  5. Get text alerts for low balances: Many banks and other financial institutions offer the ability to sign up for text alerts on certain events related to your account. Signing up for a service like this can give you a quick head’s up when your balance dips too low, so you can add funds and avoid an overdraft situation.

While overdraft protection can be a valuable financial tool and may help save you from exorbitant fees, it’s always better to avoid the situations that trigger those fees in the first place. These five strategies will help minimize or even eliminate those situations altogether.

How high are overdraft fees usually?

Overdraft fees are set by the bank. There may be state laws that limit the amount a bank can charge, but in most cases, the fees are typically around $30 to $35 per transaction. So, for example, if you write a check to your landlord for $1,000 for rent, but only have $995 in your account, you’ll have an overdraft of $5, but you’ll also be assessed an overdraft fee of $35 or so. This means that without overdraft protection, your account balance is now negative $40.

In some cases, you may be able to convince your bank to refund the overdraft fee. This is usually done as a one-time courtesy for clients who are otherwise in good standing and have a record of keeping their account balances positive. So while it’s not smart to rely on this method several times in a row, it doesn’t hurt to try it the first time.

Is it bad to use overdraft protection?

Overdraft protection generally requires you to connect your checking account to a secondary account. In most cases, that means something like a second checking account or a savings account at the same institution or bank. It could also mean a credit card. To the extent that funds or credit from that account get transferred to cover your overdraft, technically you’re out that money and will need to replenish your account balance to bring it back to the same amount. You may also have to pay a fee to use this service, although this depends on your banks’ specific policies.

However, this is a fairly small matter, considering the alternatives. Those alternatives include stiff penalties and fees, and potentially an account that’s sent to collections if you do not pay the overdraft. That could adversely impact your credit score and your ability to open up a new bank account in the future. All told, the drawbacks of overdrafts far outweigh any minor inconveniences of setting up & participating in an overdraft protection program.

Can using your overdraft protection hurt your credit score?

As a general rule, the underlying overdraft is not submitted to any of the credit reporting agencies. Consequently, an overdraft alone will not directly damage your credit score.

However, an overdraft situation can indirectly damage your credit rating if you fail to rectify the situation and bring your account back into positive status promptly. In that case, your bank or financial institution may turn the matter over to a collection agency, thus potentially dinging your credit. And damaged credit can result in a number of adverse consequences. You might have difficulty finding a new apartment to rent, getting hired for a new job, qualifying for a loan for a car, or getting approved for a number of other types of credit accounts.

Do you have to pay back overdraft protection?

Without overdraft protection, you do have to pay back the overdraft itself together with any fees that the bank assesses. It’s crucial to bring your checking account back into a net positive (or at least not a negative) status.

It’s a bit different when you have overdraft protection. Because the money that’s being transferred to cover your overdraft in an overdraft protection program is yours, you don’t have to repay that money to your secondary account in most cases. Of course, you should try to rebuild those funds to keep them available for future overdraft situations. The exception, as noted above, is when you’ve linked a credit card account to your overdraft protection. In that case, you’ll have to pay those funds back, usually at a higher interest rate and transaction fees that are applicable to cash advances.

The Bottom Line

Accidents and unforeseen events happen, despite our best efforts, so overdrafts can easily occur even when you’re intent on avoiding them. An overdraft protection program is an easy, no- or low-cost way (depending on your bank’s rules) to provide a backstop against overdrawing your account and incurring fees that can accumulate quickly and cause even further financial damage.

Be sure to ask about your bank’s overdraft protection program and its terms and conditions. It’s important to read those terms and conditions carefully so you understand your obligations and the limitations of the program before you rely on it.

About the author

John Boitnott is a longtime digital media consultant and journalist who covers technology trends, startups, entrepreneurship and personal finance for Inc, Entrepreneur, Business Insider, USA Today and other major publications.

About the reviewer

Ana Gonzalez-Ribeiro, MBA, AFC® is an Accredited Financial Counselor® and a Bilingual Personal Finance Writer and Educator dedicated to helping populations that need financial literacy and counseling. Her informative articles have been published in various news outlets and websites including Huffington Post, Fidelity, Fox Business News, MSN and Yahoo Finance. She also founded the personal financial and motivational site www.AcetheJourney.com and translated into Spanish the book, Financial Advice for Blue Collar America by Kathryn B. Hauer, CFP. Ana teaches Spanish or English personal finance courses on behalf of the W!SE (Working In Support of Education) program has taught workshops for nonprofits in NYC.

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Written on February 22, 2022
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