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Understanding Overdraft Protection and Fees

At one point or another, it’s happened to nearly all of us: For one reason or another, we spent more than our available checking account balance. And most likely, we wound up paying an overdraft fee for the privilege. In years prior to the day I “smartened up” financially, I probably gave my credit union several hundred dollars in overdraft fees because I was frequently either careless, broke, or both.

Needless to say, in the years since then, learning to balance my checkbook and save financial reserves has saved me untold amounts of money. If you want to do the same, it’s important to understand why overdraft protection exists and how it works.

And that’s never been more important than today, because the way banks handle overdraft protection features (and the accompanying fees) is changing.

Overdraft Protection 101

In the days before debit cards, if you wanted money from your checking account you either went down to the bank and got cash or you wrote a check. Obviously, if you didn’t have money in your account, the bank teller wouldn’t give you money. Similarly, if you wrote a check and didn’t have money in your account, the check would bounce. Not only would your bank charge you a fee, but the merchant to whom you wrote the check would also charge you a fee.

Enter overdraft protection: Banks realized that bouncing a check wasn’t just costly for customers, it was also embarrassing and inconvenient. So banks began offering overdraft protection, often automatically. With overdraft protection, if you write a check that you don’t have the money for, your bank will still clear it (up to a certain amount) and make your checking account balance negative. Then they will charge you an overdraft fee typically between $30 and $40. The bank still gets their fee, but the customer is spared the embarrassment of bouncing a check. Not many people complained.

But when debit cards came along, overdraft fees became a problem. All of a sudden we’re using our debit cards several times a day and for practically everything from monthly bills to $2.13 cups of coffee. That makes it infinitely harder to keep track of our checking account balance (assuming we balance it at all). So if you’re running low of funds on the day before payday and use your checking account to pay a bill and for two debit card transactions, you could face not just one but three overdraft fees.

How is that possible? Many banks clear larger dollar-amount transactions first. So if you had $99 in your account and paid a $100 bill and then bought a $15 lunch and a $2 cup of coffee, the bank would deduct the $100 bill from your account first, leaving you with a balance of -$1, charge you a $35 fee, then process your $15 lunch, charge another $35 fee, and finally deduct your $2 cup of coffee and charge you one more $35 fee. Ultimately overdrawing your account by $18 could cost you $105.

How Overdraft Protection is Changing

Bank of America made a splash this week when it announced that beginning this summer, the bank will no longer charge customers $35 overdraft fees on debit card transactions. Going forward, if you don’t have enough money in your checking account and you try to make a debit card purchase, Bank of America will decline the transaction. That’s probably how it should be: no money, no latte.

And change isn’t just happening at Bank of America. New federal regulations taking effect July 1 will require that banks only charge debit-card overdraft fees to consumers who opt-in for the feature. So if you’re a Bank of America customer, you won’t be able to overdraw your account via debit card unless you’re at an ATM, in which case the machine will ask you if you want to overdraw and pay a fee. But if you bank elsewhere, you get to choose whether you want to be able to spend more than you have in your account by debit card and pay overdraft fees or if you just want your transaction to be declined.

But overdrafts aren’t disappearing altogether. Banks can still charge overdraft fees on checks and recurring electronic debits without customers’ consent. (Translation: You still need to track your spending and balance your checking account!) On the flip side, however, you can still use overdraft protection in a pinch if you’ll face stiffer penalties for not paying a certain bill on time. (Ideally, of course, you should budget and save enough money so that you’re not scraping the bottom of your checking account).

Avoiding Overdraft Fees

If you’re a good customer and you ask nicely, banks may forgive your first one or two overdrafts and refund the fee. Larger banks even have specific formulas for deciding when to excuse certain fees. But don’t count on getting a freebie. In most cases, overdrawing an account is your fault and the fee is the penalty. The goal is not to do it in the first place and, if you do it once, try not to make a habit of it.

Automatic electronic funds transfers from your checking account can be another source of overdrafts. If you’re currently paying monthly bills via automatic debit, consider setting up a bill-pay account to automatically move the money from your checking account to the biller instead of the other way around (most banks won’t make a bill-pay transfer if you don’t have the cash but will allow an auto debit to go through). Check with your financial institution just to be sure.

Lastly, if you frequently overspend, do not opt-in for overdraft protection on your debit card this summer. Get a better handle on your budget and save up an extra few hundred dollars to cushion those weeks in which your checking account is running low.

Learning to avoid overdraft fees can save you hundreds of dollars a year and can even make your finances healthier in other ways too. The new regulations this summer will help, but only your commitment to budgeting and moving away from living paycheck-to-paycheck can guarantee an escape from the overdraft trap.

Published or updated on March 12, 2010

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.


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  1. rein says:

    So if i say I have a $100 deduction for an OVERDRAFT PROTECTION, does this mean I have a spare of $100 that the bank keep just in case i dont have enough on the checking account.?

  2. David Weliver says:

    Good point, Honey. I have this option set up on my account, although oddly enough there is still a $5.00 fee if I were to use it (certainly better than $35). That linked savings account ends up being just for OD protection because it has such a low interest rate.

    The other options that some banks offer are overdraft lines of credit. They require a credit check and instead of charging a flat fee, they simply charge interest on the amount your are overdrawn. If you repay ovedrafts quickly, that easily the least-expensive option.

  3. Honey says:

    Whatever happened to linking a savings account to your checking account and using that as overdraft protection?

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