When you try to make a transaction that exceeds your account balance, your bank will either decline the transaction or let it go through (usually for a fee), causing your account balance to go negative and be overdrawn. What the bank does depends on if you have an overdraft protection plan, and if so, what option you chose when you opened your account.
Overdraft fees can be costly – not only is there an annual fee to have the protection, but most banks charge $35 when you incur a negative balance on your checking account. So if you overdraw multiple times in one day (or even multiple times a month), these non-sufficient funds fees can easily be your biggest banking expense. While many banks offer “overdraft protection,” this is sometimes just as costly as an overdraft fee. The annual fee for an account that has at least one overdraft or non-sufficient funds fee can be about $255 a year for these services.
Like we said, you choose an option when you open your account. You have three choices:
| Overdraft option | What happens to the transaction? | Fee |
| Default setting | Rejected by the bank and merchant at the point of sale | $0* |
| “Overdraft Protection” | Bank processes the transaction by transferring funds from a linked account | $10-12 |
| Overdraft Coverage | Bank processes transaction, pays the merchant | $35 |
*However, you will be charged a bounced check fee or incur penalties for being late on your bills because the transaction doesn’t go through
How can you avoid overdraft fees?
Here’s what we suggest:
- Decline the Overdraft Protection. This is a very expensive option that everyone should avoid. Accountholders who were heavy overdrafters but who opted out of the service saved on average more than $600 per year. If you are someone who overdraws frequently, look into a bank that doesn’t charge a transfer fee. Ally Bank, for example, offers no-fee transfers from a linked savings account, as do many credit unions.
- Use Your Bank. Online banking has made it easy to track your spending, but what many people don’t know is that some online banking systems can give you valuable advance notice of an overdraft. If you have an overdraft pending, the key is to get money transferred into your checking account before the end of the same day. If you have a savings account at the same bank, transferring money online is often the easiest way to get the job done. If not, though, going to a physical bank branch with money to deposit can save you a costly fee down the road. Note, though, that not all banks allow this strategy. Check with your bank to find out which methods it uses, and then plot your plan of attack accordingly.
- Budget Better. Simple enough, if you watch your spending and take into consideration all of your costs and deposits, you can save yourself a lot of money in the end. A common tactic is to trick yourself by always having extra money in your account that you don’t include in your budget. That way you can spend accordingly, and if you go over a little bit you’ll have a “safety net” to avoid the overdraft fee. Banks and credit unions totaled $32 billion in 2012 of overdraft charges. This is a ridiculous amount, and if you keep your money in check you can avoid adding to that number, as well as have a little more to spend on you.
It is very important to not spend more than you make for many reasons, overdraft fees being one of them. Hopefully you’ll keep this in mind for the next time you go to the bank, and opt out of Overdraft Protection.