Have you ever had a transaction get 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 which can cost between $25 – $50 depending on the institution.
That’s where overdraft protection comes in. With overdraft protection, you can complete your transaction when you need it and it gives you time to reconcile your account. To determine if you can benefit from adding overdraft protection to your bank account, it’s important to understand how it works.
How Does Overdraft Protection Work?
Overdraft protection is an optional add-on for many bank accounts, though more premium versions may already include it. When the bank refers to overdraft protection, it’s against a transaction bouncing. Whether it’s a cheque, direct withdrawal, or debit, the bank compensates for the difference. Essentially it helps cover the cost of a transaction even if you don’t have any money in your account.
For example, if you have $20 in your account, but make a $50 purchase, you’ll end up with an account balance of negative $30. Moreover, depending on the bank, you’ll be charged an overdraft fee and interest.
The amount of overdraft protection you have depends on a range of factors, including your history with the bank and your personal banking needs.
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.
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 will usually charge a transactional fee and may also charge you for the amount of time that you are overdrawn.
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 $5 fee which may be charged every month or by each overdraft transaction. Moreover, you’ll be charged interest on the amount overdrawn until you bring your account balance back to zero. Interest charges range between 19% – 22%.
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, though each institution usually charges per overdraft transaction or on a monthly basis.
Interest is also 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.
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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 depend on the bank and your financial situation. Like any other form of credit, it requires prudent research before you get started.
- Good For Emergencies – Overdraft protection can add convenience when shopping and function as an emergency backup if you are temporarily short on funds.
- Flexible Way Of Borrowing – If you’re unable to qualify for a credit card because you have bad credit, are a student or are new to Canada, overdraft protection can be a way to borrow money without having to apply for credit.
- Avoid NSF Fees – A major benefit of overdraft, is that it avoids multiple NSF costs. For instance, if you have 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. In this situation, you pay an NSF fee both to the bank and to the utility company. When you do have overdraft, you are only responsible for that one service fee.
Overdraft protection isn’t a perfect financial product, especially if you’re worried about an inability to repay.
- 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 pay the amount overdrawn promptly, it’s a great service. If it’s left unattended, the interest and fees together 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.
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What’s The Difference Between An Overdraft Fee And An NSF Fee?
Though both expenses are a result of an account lacking sufficient funds to complete a transaction, there are distinct differences between overdraft and an insufficient funds fee (NSF). To understand whether overdraft is appropriate for your account, it’s important to know the difference between these two costs.
A non-sufficient funds fee is a cost that you incur when you try to process a transaction without enough money in the account to pay for it. The NSF charge can come from the financial institution that couldn’t process the transaction. It can also come from the party trying to process a withdrawal, such as a lender or service provider. The NSF charged by these parties is usually significantly higher than an overdraft fee, ranging from approximately $25 to $50.
An overdraft fee is the cost of service for overdraft transactions. 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. However, the charge is substantially smaller than an NSF fee. The most common charge is $5 for each time you use the overdraft.
Keep your eyes peeled for other bank withdrawal fees.
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, but the most significant is to create a budget and stick to it. By monitoring your finances routinely, you can avoid the hefty fees often associated with unattended overdrafts.
Pay Balance During 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. Some banking institutions offer a one-day grace period. 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 saving accounts. This option can help you avoid the interest associated with the service.
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.
Does overdraft affect your credit?
Can you go into overdraft if you have no money?
What happens if you don’t pay your overdraft?
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, in the event that you need it, overdraft can be a helpful service. Proper budgeting of your expenses is the first step towards financial health. Overdraft can be a helpful tool, similar to a line of credit, to help you prepare for emergencies. When used in conjunction with a well-structured financial strategy, overdraft can serve your household well.