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What is overdraft protection?
Key takeaways
- Overdraft protection covers transactions when your checking account balance can’t—preventing declined payments and potential credit score damage
- Protection options include linked savings or checking accounts, credit cards, or overdraft lines of credit, each with different fees and limits
- Banks may charge fees for overdraft protection and may apply interest charges when using credit cards or lines of credit
A bill that you forgot about gets paid. The money you're expecting from a friend doesn’t arrive. An insurance premium is automatically debited from your checking account.
Life happens, and suddenly, your checking account has insufficient funds to cover all your transactions. It's called an overdraft, and it could cost you. Too many of them may even impact your credit score.
But here's the good news—your bank might have your back by offering overdraft protection . Setting up overdraft protection could save you money, prevent declined transactions, and give you peace of mind.
Let's look at different forms of overdraft protection and how to set it up.
How overdraft protection works
Overdraft protection is an agreement between you and your bank that it will cover your overdrafts up to a specified limit and up to a certain number of times each month. There may or may not be a fee for this service, so read the bank policy regarding overdrafts carefully.
If your checking account balance falls below zero, you may have several options for overdraft protection:
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Linked account, either savings or another checking account at the same institution. You can authorize the bank to make an automatic transfer out of one bank account to bring the overdrawn account up to zero
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Credit card. If your checking account gets overdrawn, the bank can tap available funds on a credit card to cover your transactions. Again, there may be a fee, and you may have to pay interest on your credit card
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Overdraft line of credit. This works like credit card overdraft protection, but without the card. It may be subject to a credit limit
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Grace period. Many banks offer customers a brief window to cover overdrafts themselves before applying overdraft protection or charging a fee
Paying attention to your bank balances, your outstanding checks, ATM withdrawals, and other transactions is the best form of overdraft protection. Your bank might also offer the option to set up alerts when your balance drops below a certain dollar amount, so you can act before overdraft protection kicks in.
Benefits of overdraft protection
Overdraft protection can give you some peace of mind when your checking account unexpectedly heads into negative territory. There are also other important benefits:
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Prevent declined transactions. Having your debit card declined while trying to make a purchase can be embarrassing and confusing. Overdraft protection will let those transactions get completed
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Avoid overdraft fees. Your bank may cover an overdraft, but it also could charge a fee for that service
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Protect your credit. Overdrafts by themselves don't show up on a credit report. But if bills are paid late because of overdrafts, it could potentially impact your credit score
Overdraft protection costs
It's good to have overdraft protection in your corner, but there may be fees associated with it.
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Transfer fees. If funds are being transferred from a credit card or overdraft line of credit, the bank might charge a transfer fee. The same is true if the bank is covering your overdraft at its discretion. However, you might avoid such fees by having one or more linked savings accounts or checking accounts for overdraft protection
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Interest charges. Overdraft protection from a credit card or line of credit is treated as a loan and typically comes with higher interest than a typical purchase. Also, interest is charged from the first day of use
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Transfer limits. Most banks limit the amount they'll cover for an overdraft, typically between $100 and $1,000. They are, however, under no obligation to cover customers' shortfalls
How to set up overdraft protection
Banks typically make it easy to sign up for overdraft protection. There are usually several different options for you to pick from: linked savings accounts, additional checking accounts, overdraft lines of credit or credit card back-up.
If you're not sure which one is best for you, talk to a banker or a customer service representative.
FAQs
Overdraft protection does not directly affect your credit score, as checking account activity is not reported to credit bureaus. However, if you fail to repay an overdraft from an overdraft line of credit or credit card, or if an unpaid overdraft balance leads to your account being sent to collections, then your credit score might be impacted.
Essentially, it's the difference between your money and the bank's money. With overdraft protection, you're using your own funds, from a linked savings account, checking account, credit card or line of credit to cover a transaction. However, you may be required to pay a fee for overdraft protection. Overdraft coverage is the bank using its own money to prevent declined transactions, and they typically will charge you a fee for the service.
Without overdraft protection, transactions that would overdraw your account are typically declined or returned unpaid. In other cases, some payments may still go through, but having non-sufficient funds (NSF) on an overdrawn account can lead to additional charges or trigger fees. If your account has a consistent pattern of declined or returned payments, your bank could flag it and restrict features (like check writing) or in extreme cases, even close your account.