What is an Overdraft?
Overdraft is a term used when withdrawals made from a deposit account are more than the available funds, which result in a negative balance. Typical transactions that could cause an overdraft include checks written, automatic payments or transfers, debit card purchases or ATM withdrawals.
Overdrafts can occur for a variety of reasons. Here are just a few of the more common examples:
Addition or subtraction error, resulting in less in your account than expected
An item in your deposit was returned and you already had made payments against the deposited amount
Forgetting to make a deposit
Automatic payment not entered in your register
Soft holds-you may have used your card for a hotel stay and an amount representing your room fees is placed on hold-even though the final amount may be less, or you may not use that particular card for final payment.
When an account is overdrawn, the financial institution must make a decision whether to allow payment of the transaction(s) that caused the overdraft. Financial institutions incur costs to manage these situations and potentially could pass those costs on to you, in the form of overdraft, non-sufficient fund or return check fees. In some cases, you may desire that an important transaction be paid, such as a mortgage payment or utility bill.
Overdraft Privilege or Overdraft Protection plans are available through most financial institutions and are designed to pay transactions presented against a checking account with insufficient funds. These services can help ensure your most important transactions are processed and also help you avoid the embarrassment associated with refused or returned transactions.
Overdraft Coverage Options
Banks and credit unions typically offer different overdraft coverage options that are designed to protect you in the event of an overdraft. The options vary by financial institution and may also carry a range of related fees. The following will outline some of the more common options available at many financial institutions.
Overdraft privilege, sometimes referred to as "courtesy pay", is a service that pays items that are presented for payment on accounts with insufficient funds. The transactions covered can include checks, ATM withdrawals, debit card purchases and electronic transfers. Many financial institutions will impose an overdraft fee for each item presented for payment against an overdrawn account on a given day with a maximum total charge per day. Overdraft fees vary by institution and typically range anywhere from $10 to as much as $38 per item.
A common practice has been for financial institutions to automatically cover your ATM and one-time debit card transactions, even if you weren't aware that you didn't have enough in your account to cover the transaction. For instance, it would have been possible to be assessed an overdraft fee, or multiple fees triggered by a small purchase using your debit card.
Effective July 1, 2010, financial institutions had to comply with new rules that address overdraft privilege services. The following outlines the two major changes that impacted payment of transactions that could cause an overdraft on your account:
Financial institutions are prohibited from charging overdraft fees on ATM or one-time debit card transactions that cause an individual's account to overdraw.
Account holders must "opt-in" to allow overdrafts to be paid, and fees to be charged, on their account.
It is important to note that this new rule does not affect overdraft privilege services that may be in place with regard to checks and automatic payments that may trigger an overdraft.
Other Overdraft Protection Options
Financial Institutions may offer alternative options to cover overdrafts in addition to traditional overdraft privilege services. Overdraft Protection generally involves the linkage of another account to your checking account. When there are insufficient funds in your account to pay a transaction, funds would be transferred to cover the amount of the overdraft. There may be fees associated with Overdraft Protection programs, however they typically are much lower, making it a more attractive option to protect your account. Below are a few examples of Overdraft Protection options that may be available at your bank or credit union.
The amount of the overdraft is transferred from your savings account and will cover the total amount of transactions presented on a given day. Typically a nominal fee would be charged for this type of Overdraft Protection. Note, that Federal Regulation D limits certain types of withdrawal and transfer transactions you can make out of savings accounts to six per month.
The amount of an overdraft is covered through an advance made from an eligible credit card issued by your financial institution (subject to credit approval). In addition to a transfer fee, the amount transferred may be subject to credit card interest charges, based on the type of transaction and length of time the balance is owed.
Line of Credit
A line of credit is accessed in a similar fashion as a credit card. The available credit on this type of account is determined by your financial institution through an application and credit review. Upon approval, the line can be linked to your checking account. Should you overdraw your account, funds are advanced from the credit line to cover the overdrawn amount. You could be charged interest based on the length of time the credit balance is outstanding, and other fees may apply.
These are a few of the more common Overdraft Protection programs that may be available. The type of coverage and terms will vary by bank or credit union. Check with your financial institution to learn more about options available to you.
Do you need protection against potential overdrafts?
Overdraft coverage is available on most checking accounts. Whether you choose to have overdraft protection really depends upon your own unique financial situation. Typically, there are no costs associated with signing up for overdraft privilege or protection programs. You would only be charged if an overdraft is covered. It's there when you need it. Be sure to check with your institution to review overdraft program options and potential costs.
You may want to consider protecting your account from an unintentional overdraft caused by a simple omission of a transaction or addition error in your register, even if you have never overdrawn your account.
Effective Money Management Tips
Here are a few tips to help you manage your account to avoid overdrafts and associated fees.
- Sign up for direct deposit. To make sure you have funds in your account when your transactions come through is to set up direct deposit for regular deposits including your paycheck and any other regular payments you receive (like government payments).
- Keep your account register current. Record your transactions in your register right away and update your account balance. Be sure to record ATM and debit card transactions as well as online purchases and account service fees.
- Track automatic deductions. Payments and deductions for loans, utilities, insurance, even savings can be convenient because they are automatic. Remember to record recurring payments in your register.
- Keep a balance cushion. One way to help safeguard your account against overdrafts is to keep an extra "cushion" of money in your checking account that your balance never falls below. It will help ensure you have your own protection in the event you forget to record a transaction or make an addition or subtraction mistake, for example.
- Monitor your account balance. You should check your account balance routinely - there are many convenient ways to access balance information. You can check account balances online (or your mobile phone if your institution offers this service), call the automated phone service or call center, or do a balance inquiry on your institution's ATM. Make sure you're verifying your actual balance that doesn't include any advances made through your overdraft protection plan.
- Verify your deposits. Make sure your deposits have been credited to your account before you make a debit card purchase or write a check.
- Set up account alerts. More and more institutions offer a variety of email and text message alerts to help account holders stay on top of their account balances and transactions. Check with your institution to see if you can set up alerts on your account.
- Minimize ATM fees. You can avoid ATM fees by using your financial institution's ATMs whenever possible and simply asking for cash back on your debit card purchases.