What is overdraft protection?

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Losing track of your checking account balance is easy enough to do, yet it may lead to costly overdrafts when you swipe your debit card at the store, restaurant or gas pump. Overdraft protection can serve as a solution, as it automatically transfers money from a linked account when your checking account would otherwise be overdrawn.

This bank-provided service helps you avoid the hassle and embarrassment of declined transactions, overdraft fees and returned check fees.

How does overdraft protection work?

Overdraft protection works by linking another deposit account, a line of credit or a credit card to your checking account. Then, whenever you withdraw more money than you have in your checking account, funds are automatically transferred from the linked account to your checking account so the transaction will clear.

A per-transfer fee may apply, but it may be substantially less than what you would otherwise be charged for overdrawing your account.

Many consumers opt for overdraft protection since overdraft fees tend to be steep. The average overdraft fee is a hefty $26.61, according to Bankrate’s 2023 checking account fee survey.

Example of overdraft protection

Suppose your checking account has a balance of $90, and you use your debit card at the grocery store for a purchase totaling $100. What’s more, you have overdraft protection set up in the form of a linked savings account. When you swipe your debit card, an automatic transfer takes place from your savings to your checking account to cover the additional $10 needed for the transaction.

If your bank doesn’t charge an additional fee for overdraft protection transfers, the amount that will be transferred will be the exact amount needed to cover the transaction.

Types and costs of overdraft protection

There are several ways to arrange overdraft protection. One or more options may be available to you depending on where you bank.

These options include:

• Linked deposit account: Another checking account or a savings account is linked to the protected account. You may pay a transfer fee when the protection is triggered, but any such cost is still likely cheaper than paying an overdraft fee. You’ll need sufficient funds in your linked deposit account to cover the overdrawn amount to use this service.
• Overdraft line of credit: This feature links your protected account to an established line of credit. You borrow against that line of credit to cover the shortfall when you overdraw. In addition to a transfer fee, you’ll pay interest on the borrowed balance until you pay it off.
• Linked credit card: This service works similarly to an overdraft line of credit except the account is linked to your credit card. When an account is overdrawn, a cash advance from a credit card automatically covers the amount. You’ll usually pay a fee for the cash advance as well as the interest on the balance.

For overdraft protection that uses a line of credit or a linked credit card, it’s important to know the interest rate you’ll pay on any transferred balances. Rates vary by institution and account type. Review the terms and conditions before signing up.

A sample of banks and the fees they charge for different types of overdraft protection:

Ways to avoid overdraft fees

A current trend among banks is to eliminate or reduce overdraft fees, as banks face pressure from lawmakers and consumer advocates to curb such fees. Some banks still do charge overdraft fees, however, and those that don’t charge a fee may simply deny transactions that would bring you to a negative balance. Here are some ways to avoid being hit with overdraft fees as well as to keep from reaching a negative balance:

• Keep a close eye on your account balance. This can help you know when to stop spending — or transfer money into your account — if the balance gets too low. If your tendency to overdraw is driven by overspending, create a budget that better suits your spending patterns.
• Choose an account that doesn’t cover overdrafts. Banks such as Varo don’t charge overdraft fees. Rather, a transaction will decline when there’s not enough money in the account.
• Tell your bank not to cover overdrafts. When banks offer overdraft services, you have the right to decline them. As such, they’ll deny transactions when your account doesn’t have adequate funds.

Do you need overdraft protection?

Whether you need overdraft protection is largely a matter of your spending habits. Overdraft protection could be a good way to avoid hefty overdraft fees if you overdraw your account frequently.

Overdraft protection isn’t always free. If you use a linked credit card or line of credit, you may run up a significant balance and end up paying a lot in interest.

You shouldn’t have an issue if you use overdraft protection as a convenience to make sure the transactions clear when you occasionally overdraft, and you quickly repay any cash advance.

Bottom line

Overdraft protection can be a safety net for anyone who has enough in a savings account to cover an occasional overdraft, or those who will likely be able to pay off an overdraft cash advance in a timely manner. An overdraft protection transfer may also help you from having to pay significant overdraft fees.