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Nearly everyone has been faced with a situation where their bills exceed the amount of money in their checking account. This can happen when you’re faced with an unexpected expense like when your hot water heater breaks. Or it can happen when you forget how much you have in your account and that $150 you think you have is really $15. Overdraft protection can help you avoid the embarrassment and hassle of bounced checks.
Normally, when you write a check for an amount that exceeds your account balance, the bank will refuse to pay it and charge you a non-sufficient funds (NSF) fee. If you have overdraft protection, you will have funds available to cover the deficiency. There are several types of overdraft protection available each with different advantages:
- The first type is a transfer from your savings account. Of course, this only works if you have a savings account with money in it at the same bank, but it is the cheapest form of overdraft protection. Your bank will most likely charge you a fee whenever they have to make a transfer, typically around $5. Other than this fee, there are no interest charges, or per day fees.
- The first type is a transfer from your savings account. Of course, this only works if you have a savings account with money in it at the same bank, but it is the cheapest form of overdraft protection. Your bank will most likely charge you a fee whenever they have to make a transfer, typically around $5. Other than this fee, there are no interest charges, or per day fees.
- The third type is a cash advance on your credit card. There are no additional applications with this type. You just need to tie your credit card to your checking account. Whenever you overdraw your account, your bank will cover the deficiency with a cash advance from your credit card. This will involve a cash advance fee from your credit card and then you will be charged interest on your card at the cash advance rate. That rate is usually higher than the normal APR on your card – usually in the range of 20%.
- There is a fourth type known as courtesy overdraft protection. With this type, your bank will essentially give you an instant loan to cover the overdraft. The fees involved are high - $20 to $30 per transaction. This means that if you overdraw your account by $100, but that it takes four checks to get there, you will be charged between $80 and $120 in addition to owing the $100 of overdraft.
Let’s take an example. Suppose your hot water heater breaks. It will cost $300 to replace. You have $200 in extra cash in your checking account and $1000 in your savings account. You have a busy life and you understandably forget that you could simply transfer money from your savings to checking account to cover the new water heater and avoid any overdraft fees. You also forget that you only have $200 in your checking account. If you don’t have overdraft protection, your bank will refuse to pay the check and charge you an NSF fee of $20 to $30. The merchant will also charge you a bounced check fee of $20 to $30. Your total cost for the new water heater is then $340 to $360. If you have savings-linked overdraft protection, your bank will simply transfer an extra $100 from your savings to your checking in order to cover the overdraft and charge you $5 for the transfer. Your total cost is $305 (new water heater, plus fees). If you have an overdraft line of credit, your bank will loan your $100 from this line of credit. Let’s say it takes you one month to repay the $100, the APR is 12% and the annual fee is $15. Your total cost for the water heater will be $302.25 – $300 plus one month of interest on $100 plus one month of the annual fee. If you have overdraft protection linked to your credit card, you bank will make a $100 cash advance on your credit card. Your total costs will then be $304.50 – $300 plus one month of interest at 18% APR on $100 and a $3 cash advance fee. If you have courtesy overdraft protection, your bank will give you an instant loan to cover the $100 and charge you between $20 and $30. Your total costs will then be between $320 and $330. This is cheaper than bouncing checks, but still much more expensive than any of the other options.
Let’s take an example. Suppose your hot water heater breaks. It will cost $300 to replace. You have $200 in extra cash in your checking account and $1000 in your savings account. You have a busy life and you understandably forget that you could simply transfer money from your savings to checking account to cover the new water heater and avoid any overdraft fees. You also forget that you only have $200 in your checking account. If you don’t have overdraft protection, your bank will refuse to pay the check and charge you an NSF fee of $20 to $30. The merchant will also charge you a bounced check fee of $20 to $30. Your total cost for the new water heater is then $340 to $360. If you have savings-linked overdraft protection, your bank will simply transfer an extra $100 from your savings to your checking in order to cover the overdraft and charge you $5 for the transfer. Your total cost is $305 (new water heater, plus fees). If you have an overdraft line of credit, your bank will loan your $100 from this line of credit. Let’s say it takes you one month to repay the $100, the APR is 12% and the annual fee is $15. Your total cost for the water heater will be $302.25 – $300 plus one month of interest on $100 plus one month of the annual fee. If you have overdraft protection linked to your credit card, you bank will make a $100 cash advance on your credit card. Your total costs will then be $304.50 – $300 plus one month of interest at 18% APR on $100 and a $3 cash advance fee. If you have courtesy overdraft protection, your bank will give you an instant loan to cover the $100 and charge you between $20 and $30. Your total costs will then be between $320 and $330. This is cheaper than bouncing checks, but still much more expensive than any of the other options.
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