Did you know that if one of your bank transactions is declined due to non-sufficient funds (NSF), you could be charged a hefty fee? Fortunately, most banks have an optional service to protect you from this called overdraft protection.
However, before deciding whether you should add overdraft protection to your bank account, it’s important to understand how it works.
Key Points
- An overdraft is a service provided by your bank where you’re allowed to spend more money than you have in your account, up to a certain limit for a fee.
- The bank essentially covers the financial shortfall, somewhat like a short-term loan.
- Overdraft protection is a service provided by banks to help you avoid overdraft fees when you spend more than what you have in your bank account.
- Overdraft fees can accumulate if you routinely use more than what’s in your account, so be careful to avoid this as much as possible.
What Is Overdraft Protection?
Have you ever had a transaction declined when making a purchase? This can happen when you make a transaction that brings your account balance below zero. Unfortunately, when this happens, you’ll be charged an NSF fee.
That’s where overdraft protection comes in.
Overdraft protection is an optional service you can add to your bank account for a fee, though more premium versions may already include it for free. Overdraft protection helps cover the cost of a transaction if you don’t have any money in your account. It can protect you against many types of transactions bouncing including cheques, direct withdrawals, or debit.
The amount of overdraft protection you have depends on a range of factors, including your history with the bank and your personal banking needs.
Essentially, with overdraft protection, banks will allow the transaction to go through (up to a certain limit) even though you don’t have the funds for it, which gives you time to reconcile your account.
Overdraft Fee vs. NSF Fee?
Though both expenses are a result of an account lacking sufficient funds to complete a transaction, there are distinct differences between overdraft fees and non-sufficient funds fees (NSF). To understand whether the overdraft is appropriate for your bank account, it’s important to know the difference between these two costs.
NSF Fee
An NSF fee is a cost that you incur when you try to process a transaction without enough money in the account to pay for it. NSF fees generally cost between $25 to $50 for each rejected transaction due to insufficient funds. Transactions include:
- Regular debit transactions
- e-transfers
- Pre-authorized debits
- Personalized cheques
Overdraft Fee
An overdraft fee is essentially an NSF fee for an account with overdraft protection. Instead of being charged $25-$50 for insufficient funds per transaction, you’ll be charged about $5 per use or per month.
Note: When you make an overdraft transaction, you’ll be charged a fee plus applicable interest. Interest on the overdraft amount gets applied regularly and can compound.
Types Of Overdraft Protection Services
There are different kinds of overdraft services. Some put your balance into a negative, where the bank processes your transaction, effectively lending you the money in the interim and adding a fee. Others take the difference from a separate account that you hold with the same bank.
Regular Overdraft Protection
Basic overdraft protection involves your bank or financial institution covering the transaction themselves up to a certain limit. This service usually has a flat fee which may be charged every month or by each overdraft transaction.
Moreover, you may be charged interest on the amount overdrawn until you bring your account balance back to zero. Interest charges range between 19% to 22%.
Overdraft Protection By Linking Accounts
With this method, you connect a line of credit, a credit card or another bank account to your bank account with overdraft protection. So, when you have insufficient funds, your bank will cover the purchase through the linked account. However, the bank may charge a transactional fee and may also charge you for the amount of time that you are overdrawn.
Overdraft Protection Fees
Overdraft protection fees are charged by your bank when you use the overdraft service on your account. The specific cost varies by bank, and may be charged per month or per overdraft transaction.
Interest may also be charged on the amount overdrawn until you bring the balance back to zero. The longer your account stays in overdraft, the higher the cost. Some banks add a flat fee each day, while others calculate a yearly interest on the overdrawn amount, similar to taking out a credit card with a bank.
| Bank | Monthly Overdraft Protection Fee |
| TD | $5 |
| RBC | $5 |
| CIBC | $5 |
| BMO | $5 |
| Scotiabank | $5 |
Pros And Cons Of Overdraft Protection
As with any other financial product on the market, there are benefits and disadvantages to its use. The specific pros and cons of overdraft protection depend on the bank and your financial situation. Like any other form of credit, it requires prudent research before you get started.
Pros Of Overdraft Protection
There are a few benefits of overdraft protection, including the following:
- Avoid NSF Fees – A major benefit of overdraft is that it avoids multiple NSF costs. For instance, if you have a direct withdrawal from your bank for utility bills and your account does not have sufficient funds for the transaction, then it’s declined without overdraft protection. In this situation, you pay an NSF fee, which can be as high as $50.
- Covers You From Additional Fees – Besides avoiding NSF fees, having overdraft protection allows you to pay your regular bills, so you can avoid any potential interest charges from merchants
Cons Of Overdraft Protection
Certain costs may be associated with overdraft protection, which you should consider before allowing your bank account to go into overdraft:
- Fees – Depending on the agreement you have with the financial institution, you may be charged a monthly fee or a fee per overdraft transaction.
- Interest – The amount overdrawn will accrue interest over time, comparable to that of credit cards. If you don’t bring your account back up to at least zero, the interest and fees together can cause the debt to accrue at a faster rate.
- Impact On Credit – If you don’t restore your negative balance back to zero in a reasonable amount of time, the bank may close your account and forward the amount owing to a collections agency. This can negatively impact your credit.
How To Avoid Overdraft Fees?
Having overdraft protection on your bank accounts is a prudent way to manage your finances, but the ultimate goal is to avoid using it. There are several different approaches to avoiding overdraft, including the following:
Track Your Spending
The best way to avoid an overdraft fee is to manage your spending habits. If in doubt, use online banking to check the balance in your account before you make a large purchase. Establish a calendar for automated payments and withdrawals to identify any risk of going into a negative balance.
By addressing these issues well ahead of time, you can prevent any need for overdraft as an emergency solution.
Create A Budget
If you don’t already have a budget in place, now is the time to make one. Creating a budget and sticking to it allows you to monitor your finances so you can avoid the hefty fees often associated with unattended overdrafts.
Pay Balance During The Grace Period
The sooner you address the negative balance, the less you owe on the overdraft amount. This helps you avoid paying any interest on the amount you overdrew. If you repay the amount during the same business day as you withdrew it, then they may overturn the fee.
Link Your Credit Card Or Savings Account
As previously mentioned, you can have your bank cover your overdraft transactions (when you don’t have enough funds) by drawing funds from your credit accounts or savings accounts. This option can help you avoid the interest associated with the service.
Bottom Line
Overdraft protection is one of many financial tools that allow you to have peace of mind when doing your day-to-day banking. While the ultimate goal is to avoid using it, overdraft can be a helpful service in the event that you need it. Overdraft protection can be a helpful tool, similar to a line of credit, to help you prepare for emergencies. But ultimately, you’ll want to manage your finances appropriately to avoid overdraft fees as much as possible.
