Life happens, and even the best budgeters may experience an oversight that sends their checking account into the negatives. When this occurs, overdraft protection can help.
What is Overdraft Protection?
If you write a check or make a payment that exceeds the amount of money you have in your account, the transaction will likely not go through, and if it does, you may have to pay a Non-Sufficient Funds Fee or an overdraft fee (averaging $35 per transaction) to your bank.
This can lead to high additional fees on your checking account, and embarrassing scenarios of having your card decline or check bounce.
Here is where overdraft protection becomes important. When you sign up for a checking account, you may decide to opt in to the overdraft protection your bank offers. If you choose overdraft protection, even in the event that you do not have enough funds in your checking account, your transaction will still process and your check will clear.
Here is how Overdraft Protection Works:
When you opt in to an overdraft program with your bank, you are able to link your checking account to a backup account that the transaction will take money from if your checking account does not have enough money to cover the cost.
This secondary source could be your savings account, credit card, or a line of credit. Like all good things, overdraft protection still comes with its price.
Even with overdraft protection, you may (depending on your bank) still have to pay overdraft fees when you exceed the funds in your account, although these fees are likely to be reduced depending on the kind of overdraft protection your bank offers.
All banks offer different forms of overdraft protection. Be sure to familiarize yourself with the terms and conditions of the kind of overdraft protection and overdraft fees you will be subject to.
The Pros and Cons of Overdraft Protection
Now that you have asked “what is overdraft protection” and have a better understanding of how it works across different banks, let me explain the benefits and possible areas of concern that people often weigh before they sign up for overdraft protection themselves.
The Pros of Overdraft Protection
The most obvious benefit is that you are able to spend or write a check for more money than what is in your checking account. Your transactions will go through, and you can rest assured that the money will come out of the secondary account you have linked to your checking account.
Overdraft protection can also make sure that your checks do not bounce if you have insufficient funds, and this can be helpful in avoiding difficulty with the people you are paying, negative marks on your credit score, or potential limitations on your ability to write checks in the future.
If you are signed up for autopay for a bill (like, for example, your credit card bill or phone bill), even if you do not have enough money in your checking account to presently pay that bill, overdraft protection will ensure that it still gets paid.
The Cons of Overdraft Protection
Taking money from your secondary account linked to your checking account with overdraft protection may cost you an additional overdraft transfer fee, which is another charge on your checking account that you will have to front for the convenience of overdraft protection.
If your overdraft protection involves a line of credit, you will have to pay interest on the money you borrow to cover the negative number in your checking account, which also results in more money that you owe.
In situations where individuals link their checking account to a credit card for overdraft protection, note that the transaction of taking money from your credit card this way actually acts as a cash advance, which is different than paying normally with a credit card; it can incur higher interest fees and should be paid back as soon as possible to avoid additional charges.
Parting Words of Advice
Overdraft protection only works if your secondary account has the sufficient funds that your current transaction requires but your checking account cannot cover. So, if you are not keeping track of your finances, and the funds in your backup account are low too, overdraft protection will not help.
The solution? Some banks offer their clients to sign up for email or text alerts when your checking account is below a certain amount. This can make sure that you are aware of your current balance, as to not spend beyond it.
Registering for online banking is another convenient way to keep track of your checking account balance. Many banks offer easy to use banking apps that you can download for free on your smartphone and keep track of your balance on the go.
In all, overdraft protection can give you peace of mind if you are worried about checks bouncing or transactions getting declined, but it is not the solution to spending more than what you have in your account. To avoid costly charges, set a budget and experiment with different strategies to keep track of your balance in order to avoid overdraft in the first place.