What Are Overdraft Fees?

How Do Overdraft Fees Work?

Spending more money than you have in your checking account is known as being overdrawn. Transactions via ATM, check, debit card payment, ACH, automatic payments or cash withdrawals can all overdraw your account. If you don't have enough money in your account to cover a transaction, the bank may decline it. However, many banks will pay for the transaction—essentially lending you money—and charge an overdraft fee.

How do overdrafts work? Suppose you have $100 in your checking account and use your debit card to make a $125 purchase. Your bank may authorize the purchase, cover the $25 you're short and charge you a $35 overdraft fee. You now owe the bank $60 ($25 + $35).

You can repay the overdraft amount and fee by putting more money into your checking account. If you can't do that right away, the bank will take the money you owe out of your next deposit.

Overdraft fees may work differently depending on the type of transaction. Banks usually authorize ACH or check transaction overdrafts and charge you an overdraft fee. This helps ensure your bills are paid on time, even if you don't have cash on hand. However, some banks decline ATM or check transactions if your account can't cover them. Whether to authorize or decline these transactions is generally up to the bank.

You have more control when it comes to debit card and ATM transactions. Typically, banks can't charge overdraft fees on ATM or debit card transactions unless you opt in to the bank's overdraft protection program. If you don't opt in, the bank will simply decline ATM and debit card transactions that your balance won't cover.

When your bank declines a transaction, they may charge you a nonsufficient funds (NSF) fee. Overdraft fees occur when the bank covers a payment for you; NSF fees occur when the bank declines your payment. Most large banks no longer charge NSF fees, according to the Consumer Financial Protection Bureau (CFPB).

How Much Do Overdraft Fees Cost?

Overdraft fees can range from $15 to $37, with many banks charging more than $30 for overdrafts. Read the terms of your checking account or contact your bank for details about their overdraft fees.

Depending on your bank's policies, you might incur multiple overdraft fees in the same day if your bank authorizes several transactions that your account can't cover. Banks generally set limits on the number of overdraft fees you can be charged in a single day. However, with some banks charging up to five overdraft fees per day, the cost of overdrafts can quickly add up.

How to Avoid Overdraft Fees

The following tips can help you avoid getting hit with overdraft fees.

• Choose an account with no overdraft fees. Many banks have stopped charging overdraft fees altogether. If you're not happy with high overdraft fees at your bank, do some comparison shopping to see how other banks handle overdrafts.
• Opt out of overdraft coverage. Overdraft fees can add up fast if your account is frequently overdrawn. On average, account holders who opt in to overdraft coverage have seven times as many overdraft fees as those who don't, one CFPB study found. Opt out, and your ATM and debit card transactions will be declined if you don't have enough money, but that can be a small price to pay for savings.
• Cover overdrafts with a linked account. Some banks provide overdraft protection by connecting your checking account to another account at the same bank. Opt in to this service, and when your checking account has insufficient funds to pay for a transaction, the bank will transfer money from your linked account to cover it, with no overdraft fee. You may be able to link to a bank account, line of credit or credit card. If using credit, make sure you understand when to repay what you borrow to avoid incurring interest.
• Monitor your bank account balance. When you have lots of pending transactions, such as upcoming autopayments, it's easy to become overdrawn. Check your account balance regularly, and you'll know if you have enough funds to cover a transaction.
• Set up account alerts. Visit your bank's website or use the mobile app to set up email or text alerts when your account balance dips below a certain level or when a large transaction takes place. If you expect your rent check for $1,000 to clear in a few days, for instance, getting notified that your balance is $200 can alert you to transfer funds to avoid an overdraft fee.
• Call to request a fee refund. Depending on your bank's policies, you might be able to get an overdraft fee refunded by contacting the bank and explaining what happened. You'll generally have better luck with this if you're a longtime bank customer and don't have a history of overdrafts.
• Repay the overdraft quickly. Some banks won't charge overdraft fees if you bring your account balance above $0 within a grace period—generally the next day.
• Maintain a cash cushion. If it's doable for you, keeping some extra money in your checking account can help prevent overdrafts. Make a budget to get a handle on your monthly expenses; then put $250, $500 or $1,000 more than that amount in your checking account to cover any unforeseen charges (and don't spend it).

The Bottom Line

A growing number of banks are reducing or eliminating overdraft fees, but they can still add up if your checking account balance often drops below $0. Frequent overdrafts can also be a red flag that you're not living within your means. Unpaid overdraft fees could even affect your credit score if the bank sends your account to collections.

Setting a budget and keeping track of your bank account balance can help you prevent overdrafts, avoid potentially costly fees and achieve your financial goals. While you're at it, consider signing up for free credit monitoring from Experian. You'll get alerts about spending, changes to your credit report and activity that could indicate fraud. It's an easy way to keep tabs on your financial health.