Should You Sign Up for Overdraft Protection?

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Overdraft protection helps ensure your purchases and bills are paid for even if you don't have enough money in your checking account. The convenience of overdraft protection typically comes with a cost, however. With this in mind, is signing up for overdraft protection a good idea? While there are some benefits to overdraft protection, it also has risks to be aware of. Keep reading to decide if overdraft protection is right for you.

What Is Overdraft Protection?

An overdraft occurs when you try to pay with a debit card or electronic payment, write a check or withdraw money but don't have sufficient funds in the account to cover the amount. With overdraft protection in place, the bank authorizes the transaction and pays the amount for you rather than declining it. The bank is essentially lending you the money to cover the cost, and charges an overdraft fee for doing so. To bring your balance above zero, you can deposit or transfer funds into your checking account.

Banks offer overdraft protection on checking accounts as a convenience to prevent the embarrassment of having your card declined in the checkout line and help ensure you don't miss payments on your bills. Suppose you schedule an electronic payment of $200 to your credit card company, but when the scheduled payment date arrives, your account only has $100 in it. Without overdraft protection, your payment would be rejected. The credit card company might charge late fees or returned payment fees or even impose a penalty APR (a higher interest rate on future purchases). With overdraft protection, the payment goes through as planned, but you'll owe your bank an overdraft fee.

How Much Does Overdraft Protection Cost?

Adding overdraft protection to your checking account is generally free; you pay only when you use it. The average overdraft fee is $35, and you can face multiple fees in a single day (although some banks limit that number).

Overdraft fees work differently depending on the type of transaction. If your account becomes overdrawn due to a check, ACH transaction or recurring electronic payment, banks and credit unions can charge you an overdraft fee, even if you didn't enroll in overdraft protection. However, they can't legally charge you for overdrafts due to ATM or debit card transactions unless you've opted into overdraft protection. Not sure whether you've signed up for overdraft protection? You can find out through your bank's website or mobile app or by contacting your bank.

Failing to keep enough money in your checking account can lead to other fees besides overdraft charges. When a payment by electronic transaction or by check is returned because your account has insufficient funds to cover it, your bank may charge a nonsufficient funds fee. Unlike an overdraft fee, which is charged when the bank authorizes the transaction and covers it for you, a nonsufficient funds fee is charged when the transaction is declined.

Do Bank Overdrafts Affect Your Credit Score?

Overdrafts on your checking account don't affect your credit score directly. Checking accounts don't involve borrowing money, so they aren't part of your credit report. However, if you don't pay the overdraft fees or the amount overdrawn, the bank may send your account to collections, which can negatively affect your credit score.

If you're frequently overdrawn, the bank may report it to a bank reporting bureau called ChexSystems or might even close your account. It could be difficult to open a new account elsewhere if your ChexSystems report shows that you haven't managed your previous accounts responsibly.

Should You Get Overdraft Protection?

Opting into overdraft protection has both benefits and risks. On the plus side, it can ensure your automatic payments and scheduled transactions go through no matter how much money is in your checking account, eliminating worry about late fees or fines from creditors. On the downside, overdraft fees can quickly add up. According to the Consumer Financial Protection Bureau, frequent overdrafters who opt in pay on average nearly $450 more in overdraft fees than those who do not opt in.

Instead, you could explore other ways to ensure your transactions are always covered. You can set up bank account alerts that monitor your account balance and alert you if you're overspending. Visit your bank's website or mobile app to set up email, text or mobile push alerts for various events. For example, most banks can notify you if your balance dips below a certain amount; if transactions, transfers or withdrawals over a certain amount occur; or if suspicious transactions occur.

Of course, even when you're monitoring your bank balance, mistakes can happen. You might forget about a scheduled payment, or a deposit may not clear when you expected. As added protection, most banks let you prevent overdrafts by linking your checking account to a savings account. When you don't have enough money in your checking account for a transaction, the bank takes the money from your linked savings account instead. There may be a fee for this service, but it's usually much lower than overdraft fees.

Convenience at a Cost

The convenience of overdraft protection comes at a high cost and can mask bigger problems. For example, frequent overdrafts can be a sign you're overspending or not living within your means. Rather than relying on overdraft protection as a safety net, try making a budget to take control of your finances and keep your checking account in the black.