Overdraft Protection: Simplified

When most people think about overdraft fees, they are filled with dread. Overdraft fees sometimes feel like you are kicking someone who is already down as you add fee on top of fee. So what is overdraft protection and what are the fees involved? Have you ever had that embarrassing moment when a check has bounced or you handed your debit card to a merchant and they said, probably way too loudly, that your debit card had been declined? It is not only embarrassing but it could also have additional consequences that far surpass the momentary embarrassment. For example, some lenders will actually charge you an additional fee if you have a bounced check. So instead of just being embarrassed that you wrote a check for money that you do not have, you will in fact get charged extra money that you do not possess. So you are stuck in a lose-lose situation no matter how you look at it. What is the solution to avoid this terrible situation? Overdraft protection is what makes it possible to overdraw (to spend more money that you currently have in your checking account), so that you can avoid these situations. Although you have to opt-in for this type of service, usually you are given the option right when you sign-up for your checking account or credit card.

Although most people at this point are pretending that they have never actually written a check that has bounced or that they have enough money in their debit cards to pay for their essentials, there are actually many people who do in fact use overdraft protection. On average, it has been estimated that consumers (meaning you and me), pay $17 billion every year in overdraft and non-sufficient fund fees. Wow! That is a lot of money to pay for the guarantee that your card will not be declined. Although having overdraft protection on your checking account is very convenient, please note that it is not a cheap insurance policy. On average, the overdraft fee will be about $25 or even more depending on your financial institution. While paying this fee can be stressful, there are actually plenty of ways to avoid it, including using your credit card for payments that you currently do not have the money for.

You Should Avoid Overdraft Fees

Although it is very convenient, you should definitely avoid overdraft fees because they are simply an additional cost that you must shoulder for no apparent gain. Let’s use an example, imagine you are at the grocery store buying a frozen pizza for dinner. You do not realize it but you have actually spent all of your money for that salad at lunch and you currently have $1.50 in your debit account. You grab a $3.00 pizza and go to the cash register. Now, you enrolled in the overdraft protection when you opened up your account and therefore, rather than getting your card declined and avoid having to do an awkward side shuffle to get out of the way, you are able to buy your pizza and move on with your evening plans. Now, what has happened in the background is that your $3.00 pizza has put you over your account balance by -$1.50. This has activated your overdraft protection that has than charged your account $25.00. Boom! That nice frozen pizza just cost you $28.00 rather than $3.00. Although that might seem crazy, let me give you an idea of how truly insane this is: for a simple $3.00, if you were to repay this loan in a single day with a $25.00 overdraft fee, this would represent an APR (annualized percentage rate) of over 3,000 percent.

If you are overdrawing from your checking account often because you are currently having financial troubles, paying this fee repeatedly can make it very hard to become financially stable once again. As most banks have noticed that it is in their best interest to maintain their current client base rather than fighting for new clients, they have begun softening their overdraft policies. This has been done by opting to not charge an overdraft fee for items that cost less than $5.00. In our example above, this would mean that the bank would not charge the $25.00 as an overdraft protection fee but would just allow the checking account to remain at a -$1.50 until the end of the month. If at the end of the month, the individual’s account is still at a negative balance, than the bank will charge the overdraft protection fee rather than charging it immediately after the account had gone in the negatives. This allows the client a bit of time to organize their affairs and to bring their checking account balance back above $0. Even with all of this, if you are consistently overdrawing on your account, there are much easier solutions than to keep paying this fee repeatedly.

Four Tricks on How to Eliminate Overdraft Fees

Please note that not all banks maybe offer all of these alternatives and it is important to do your own research and confirm with your bank unless you are willing to switch to a different bank to get the flexibility that you may require. Here are the four main tricks in no particular order:

1.) Overdraft Line of Credit

With normal overdraft protection, you pay a fixed cost every time you go over what you currently hold in your checking account. With a revolving overdraft line of credit, you will typically pay a fixed interest rate on the negative balance that you currently owe and, if you pay this within a few days, it will only cost you a very small amount of money as this line of credit has a low interest rate. One of the only drawbacks to this method is that you need a good credit score to be approved for a line of credit. Please note that the bank will run a hard credit check to figure out if you eligible for this line of credit and this will definitely affect your credit score.

2.) Automatic Savings Transfer

Some of the larger banks will allow you to use your savings account as collateral to cover any potential shortfalls caused by an overdraft. Although it takes some time to organize it through your bank, most banks do not charge a fee to automatically transfer savings into your checking account when it drops below $0. One of the drawbacks though is that most banks limit you to 6 withdrawals a month from your savings account so if you allow an overdraft savings transfer to go through beyond your 6 transfers, you will than get charged the original overdraft protection fee.

3.) Finding a Bank with no Overdraft Fees

If you wish to find a bank with no overdraft fees, you should definitely look at the smaller / online banks. The larger banks are not yet willing to give up their overdraft fees.

4.) Connecting your Credit Card

If you currently own both a debit and a credit card with the same financial institution, you may be allowed to connect your credit card to your checking account for overdraft protection. Please note that compared to an overdraft line of credit, your credit card has a higher interest rate (usually 19.99%), so do not forget to pay off your balance before the due date to avoid the extra interest on your credit card due to the overdraft protection.