When Good People Write Bad Checks

If you’ve ever overdrawn your checking account, you know how painful those overdraft fees can be. How can you avoid paying out big time when you overspend? Banks offer a few types of overdraft protection that can keep you fee-free, but don’t think that they’re all created equal. Here’s what you need to know to make sure that your overdraft plan isn’t overblown.

Overdrafts happen. You don’t have to be a deadbeat to write a check or buy something with a debit card only to find that you’re using the wrong account, your paycheck deposit hasn’t gone through yet or you simply misjudged the amount of money you have in your checking account. And guess what, each of those cases can be the tipping point that drops your account into the red.

Plain and simple, the best way to avoid overdraft fees is to avoid overdrawing your account. These days electronic banking has made overdraft avoidance easier than ever. You can get email or phone alerts whenever you cross a low-balance threshold, you can transfer funds before a pending transaction puts you below the $0 mark and even the trusty old check register is still around as a means of keeping tabs on your spending. 

However, if you do overdraw, there are a few things you can do to keep things from spiraling out of control.

Overdraft protection is a service provided by your bank that pays for things you buy after you’ve overdrawn your account. It means you’ll avoid bounced checks, and your debit transactions will still go through, even if you don’t have any money in your checking account.

Overdraft protection began when banks had the discretion to extend preferred customers the courtesy of paying for their items when they had overdrawn their accounts. Eventually, however, overdraft protection made the switch from a generous courtesy on the part of banks to a lucrative financial service. There are several major types of overdraft protection available today.

One thing that makes overdraft protection so controversial is that banks are often able to skirt usury laws with overdraft fees, even though many people feel that overdraft protection is a loan of sorts. Loans are governed by the 1968 Truth in Lending Act. But because overdraft protection is seen as a fee-based service rather than a loan, in many cases you could be paying a hefty premium for the right to overdraw your account. You’ll see that some kinds of overdraft protection services can be a lot like payday loans.

The simplest type of overdraft protection is linked accounts. In this case your checking account is connected to another account, such as your savings account. When you overspend with your checking account, the extra money comes out of your savings account to keep you from being in the red. This is often the best type of overdraft protection, because you avoid paying the bank to use its money. However, there’s one caveat: You actually need to have money in that other account to use this. Banks sometimes charge you a small fee every time your linked account kicks in. Make sure yours doesn’t or that you can live with it if it does.

A similar kind of protection is the overdraft line of credit. With this your linked account isn’t a savings account; it’s a line of credit or a credit card. The obvious downside to using an overdraft line of credit is the fact that you’re using credit to fuel your purchase. If the linked credit is a credit card, you can also count on paying the cash-advance rate for the money you use.

Ad-Hoc, or bounce protection, is a fee-based service where banks use their discretion and can choose to let you overdraw or allow the check to bounce depending on your status as a customer. If you’ve never overdrawn before, they’re a lot more likely to cover your purchases than if your account is delinquent. With ad-hoc protection you’re charged a fee (often increasing each time you overdraw) and have to pay the money back to get your account back in good standing. The bad side to ad-hoc is that the fees can sometimes be a lot compared to the amount by which you overdraw. (For more, see The Ins and Outs of Bank Fees and How Overdraft Fees Work & How to Avoid Them.)

Also remember that with bounce protection you’re charged a fee for each transaction that overdraws the account – and banks usually order daily transactions in such a way that as many as possible will overdraw. So if you have $20 in your checking account and use your debit card for five $2 purchases and a $50 purchase, when those transactions go through the $50 will be applied before the $2 transactions, and you’ll be hit with six overdraft fees.

It’s important to remember that overdraft protection can also affect your credit score. If you have bounce protection and don’t bring your account back to good standing soon enough, you can bet that your credit score will take a hit. Also, if you use an overdraft line of credit or linked credit card, keep in mind the potential negative consequences of having that extra money on your card. 

If you are hit with overdraft fees for linked-account or bounce protection, the easiest way to avoid having to pay is to call your bank and ask. It’s as simple as that. If you’ve been a customer in good standing for a while and this is your first or second time overdrawing, it’s likely that the bank will let you off the hook.

Of course, the best choice is to not overdraw your account at all, but this is obviously not the easiest answer for many people. Overdraft protection is a huge moneymaker for banks these days, and they know it. If you are going to overdraw your account, it pays to have decided in advance which kind of overdraft protection is the most beneficial for you. For more, see Pros and Cons of Overdraft Protection.