Overdrafts can happen to anyone. Maybe a direct deposit doesn’t hit soon enough, a pending charge posts or an automatic payment clears earlier than expected — and suddenly your checking account is negative.
However, understanding how overdrafts work and what you can do to prevent them can help you avoid costly fees, declined transactions and negative balances.
What is an overdraft and how does it work?
A bank overdraft happens when you don’t have enough money in your bank account to cover a purchase, but the payment goes through anyway. When this happens, your account can go negative and your bank may charge an overdraft fee.
When a purchase, bill payment or ATM withdrawal hits and your available balance isn’t enough to cover it, your bank can typically make one of two choices. They can cover the transaction and potentially charge an overdraft fee, or they can decline it for insufficient funds.
Pending debit card transactions, holds and scheduled payments can all cause your actual available funds to be less than what’s posted — so when the charges hit, you may end up with less than you think. In many cases, overdrafts are caused by timing issues.
How much do overdraft fees cost?
The price of overdraft fees varies from bank to bank and can cost around $35 per transaction, according to the FDIC. This can add up quickly if multiple charges hit while your account is overdrawn. Even if your bank declines the transaction and your account balance stays positive, you may be charged a nonsufficient funds (NSF) fee .
However, it’s important to note that banks are required to disclose any fees connected to a deposit account. You can ask your bank about overdrafts or any additional fees you may run into. If you’re looking for a new bank, it can be a good idea to do some research before signing an account agreement — many banks are lowering, or even getting rid of overdraft fees completely.
What’s the difference between an authorized overdraft and an unauthorized overdraft?
Authorized overdraft. An authorized overdraft is prearranged with your bank and lets you overdraft your account up to a certain amount. This can act as a short term borrowing solution that can help bridge the gap between paychecks. There are often interest charges and additional fees included, but they’re typically less than an unauthorized overdraft fee.
Unauthorized overdraft. An unauthorized overdraft happens when there is no prior arrangement in place but your account has been overdrawn. In this case, you’ll likely have to pay an overdraft fee.
What is overdraft protection?
Overdraft protection is an optional service offered by most financial institutions. It helps cover transactions when your checking account doesn’t have enough funds. If you enroll, your bank may offer one or more overdraft services that can help — though fees, limits and rules will depend on your account.
Linked accounts. Your bank may allow you to link a savings account (or a money market account) that can automatically transfer funds into your checking account when your balance is low. This can help prevent declined transactions, but your bank may charge a transfer fee when a transfer happens. You may also be able to link a credit card to help cover purchases that would make your account go negative. However, you may be charged a cash advance fee with this option.
Overdraft line of credit. An overdraft line of credit lets you connect a credit line to your checking account. Because this is a form of credit, approval will likely depend on a credit check and other eligibility requirements. You’ll also have to pay fees and interest on what you use.
Grace periods. Some financial institutions won’t charge a fee as soon as an account is overdrawn. Many offer a grace period, which offers customers a short window of time to bring their account back to a positive balance. These kinds of programs can vary by bank, so it’s worth doing some research to make sure you understand your bank’s policies.
How do I avoid overdraft fees?
Budgeting
Creating a budget that works for you can help you avoid overdrafting your account. Your budget can account for both your regular bills and give you some breathing room in case you run into a surprise expense.
Start with the nonnegotiables like rent, groceries and bills. Make sure your income can cover what you need and have some left over for savings. There are many different styles of budgeting, the most important thing is that it works for you.
Balance alerts and notifications
Most banks will allow you to set up balance alerts through online banking or their mobile app. If you opt in, you can choose a dollar amount and if your account dips below that it will send a notification to your phone or email. This can help you catch potential overdrafts before they happen.
Try to set your alerts for an amount that still gives you time to take action. Whether that’s transferring funds from another account, delaying a purchase or simply checking if you have any pending debit card purchases or automatic payments due.
Savings
Savings can act as a buffer when something unexpected happens. Even a small amount set aside can help you avoid an overdraft fee. Building up your savings can feel tough, but there are a ton of different ways to save, even if you’re on a budget. You can start small and build over time. The goal isn’t to have a large sum of money saved overnight, it’s about building a small “just in case” account you can dip into during emergencies.
Emergency borrowing options
Borrowing can help you cover a gap when surprise expenses hit, but it also comes with some downsides. Before you borrow, you should look at your financial situation as a whole and make sure it’s the right move for you. Many emergency borrowing options come with high interest rates which make them an expensive way to borrow — especially if you have bad credit. If you need quick cash, there are other options you can explore before taking on a loan.
Personal loan. A personal loan can be a helpful tool if you have a large, one-time expense you need to cover. It provides a lump sum of cash up front that you can pay back in smaller installments over time.
Line of credit. A personal line of credit can act as a back up in case of emergency expenses. It gives you access to a set credit limit that you can borrow from when you need it. As you repay the funds become available to borrow again. This makes them more flexible than a personal loan and they can act as a safety net in times of emergencies.
DISCLAIMER: This content is for informational purposes only and should not be considered financial, investment, tax or legal advice.
