What Is an Overdraft Fee?
Benilyn has over a decade of experience as a banking officer. Her expertise is featured throughout Fit Small Business in personal finance, credit card, and real estate investing content.
This article is part of a larger series on Business Banking.
An overdraft fee is a banking term that refers to the charges incurred when you don’t have enough funds in your account to cover a check, withdrawal, debit card payment, or auto-debit transaction. Overdraft fees are charged when the bank temporarily covers a financial transaction against insufficient funds, which causes your account balance to go negative.
How an Overdraft Fee Is Charged
An overdraft can happen when you write checks, swipe debit cards, withdraw cash from ATMs, and set up automatic payments that are more than your available account balance. Overdrafts can cause a negative balance on your account, and banks will charge an overdraft fee for every overdraft occurrence.
Most banks will allow you to choose what happens if you try to make a financial transaction, and you don’t have sufficient funds in your account. You can opt to have the bank cover the transaction, which will make your account balance negative. When this happens, you will be charged an overdraft fee. You can also opt to have the bank decline any electronic transaction, such as debit card transaction or automated clearing house (ACH) payment, against insufficient balance and avoid the overdraft fee.
How Much Does an Overdraft Cost?
The amount of the overdraft fee often ranges between $30 to $40 per instance, but it can vary from bank to bank. It is possible to get charged with an overdraft fee multiple times in a day, and banks charge a fixed amount regardless of how much you have overdrawn.
For example, if you have a balance of $300 in your account, but you don’t know how much your current balance is. You went on a shopping spree and swiped your debit card for $320, leaving your account with a negative balance. The bank charges you an overdraft fee for this overdrawn transaction. On the same day, your account was also deducted by $50 because of an automatic payment arrangement you set up previously, which overdraws your account further. The bank will charge another overdraft fee for this particular transaction.
It’s important to know how your bank processes debit transactions to your account. If your bank clears the largest transaction first, you could be hit with more fees than a bank that processes the smallest transaction first.
Some banks also charge an extended overdraft fee if your balance remains negative for a certain number of days. Most banks require you to settle your negative balance within five to seven days before charging you with an extended overdraft fee.
Types of Overdraft Protection
Many banks and financial institutions offer a variety of overdraft protection programs to help you cover your financial transactions against an insufficient balance. Overdraft protection is an optional service that you can choose to join when you open a bank account. You will need to pay an annual enrollment fee when you join an overdraft protection program.
Here are the different types of overdraft protection programs:
- Linking another deposit account to your checking account: Some banks allow you to link your checking account to another deposit account maintained at the same bank. If your available balance in your checking could not cover a transaction, the bank will authorize a transfer from the linked account to cover it. Typically, banks will charge a fee per incident, although this fee is less than the bank charges for an overdraft fee.
- Linking a credit card: Other banks allow you to link a credit card to your checking account so that when an overdraft occurs, the credit card covers it. Typically, the bank will charge a fee per instance on top of the cash advance fee and interest.
- Overdraft protection line of credit: Some banks offer an overdraft protection plan that acts as a line of credit, which is a mini-loan designed specifically to cover overdrafts. This usually includes a fee per transaction and interest on the used balance of the line of credit. Some banks charge an additional annual fee for this service.
- Opt to have the bank cover the overdraft: If you opt-in to courtesy overdraft, the bank will cover your overdrawn ATM withdrawals and debit card purchases. You will be charged a fee for each transaction made against the negative balance.
Ways to Avoid Getting Charged With Overdraft Fees
Overdraft fees are an unnecessary expense, so it’s essential to learn how to avoid them. Here are a few ways to avoid getting charged with overdraft fees:
- Sign up for online banking: Signing up for online banking allows you to monitor your account balance anytime and anywhere. It’s important to check your balance compared to your transactions to avoid incurring an overdraft.
- Track your financial transactions: Keep track of your check transactions and automatic payments to ensure that you have enough balance in your account.
- Opt-out of overdraft coverage: Another way to avoid an overdraft fee is to opt-out of the bank’s overdraft protection. Without overdraft protection, transactions get declined if your account doesn’t have sufficient funds to cover them.
- Understand the bank’s overdraft policies: It’s essential to know and understand the bank’s overdraft policies to help you save on overdraft fees later on. Find out how your bank processes the debit transactions in one day. If your bank processes the smallest transaction first, you will have a lesser risk of getting charged with multiple overdraft fees in case you have more than one debit transaction on the same day.
- Sign up for balance alerts: Some banks let you automate the process of checking your balance by setting up email or mobile text alerts to get notified when your account falls below a certain threshold. Ask your bank if it offers this kind of facility.
- Put extra funds in your account: Create a buffer by making sure that you deposit a certain amount of money that should always be in your account. In case of emergency and you had to use it, make sure to replenish the amount as soon as possible.
What This Means for Your Business Account
Knowing the overdraft fee and understanding how it works can help you save on unnecessary costs. The cost of an overdraft fee can add up, especially if you don’t monitor your account balance and your transactions frequently. It’s critical to manage your account efficiently by avoiding financial transactions that can cause a negative balance on your account.
Bottom Line
An overdraft fee is a fee charged by the bank every time your account incurs a negative balance. This happens when you have a financial transaction but don’t have enough money in your account to cover it, so the bank temporarily covers the transaction for you. Overdraft fees can be avoided if you let the bank decline any transaction for which your account doesn’t have sufficient funds.
