Is Overdraft Protection Right For You?

Sometimes life can throw a curve ball at you and you find yourself on the boarder of over drafting your bank account.  Or perhaps your finances come down to the wire every month and over drafting your account is a possibility every month.  Trying to balance the details of life can be difficult and most Americans have faced an over draft fee.  So what can be done to avoid these fees when faced with this situation?

What is Over-drafting Your Account?

Instead of bouncing checks, banks now accept the payment and as a penalty for spending more money then you have in your account they charge you a fee.  The overdraft fee typically costs around $30-$40.

Here is one problem: Banks are cashing in from the overdraft policy. It seems better to be denied a purchase, especially a minute purchase like a cup of joe, is better then incurring  a $35 overdraft fee. But in the name of protection and avoiding embarrassment for the customer, banks institute the overdraft policy.  Quite a way to make an extra buck.

Computing Overdraft Fees

The issue of overdraft fees goes like this…

If you overdraft your account you get say a $35 overdraft fee, but it doesn’t start there.  Say your previous 4 financial transactions were $50, $30, $5 and $5, and you only have $70 in the bank.  Once processed by the back, highest amount to lowest amount, your $50 payment go through and now you have $20 in the bank.  Therefor the $30 transactions overdrafts your account and a $35 fee is enforced.  Followed by a $5 transaction AND another $35 fee, follow by another $5 AND another $35 fee.  That is $105 in fees.

How do you stop this from happening?

Many banks have the option to open an overdraft line of credit.  If you overdraft your checking account the amount you over-drafted will be pull from the overdraft line of credit (which is just like a standard LOC and charges interest).

You will be responsible to pay the balance as well as the extra interest charges on the loan.  If you pay the balance of quickly the “fees” or interest charges will be far less then the $35 or more you typically pay.

Although this is a good alternative to paying high overdraft fees it can cost you much more if you continually hold a balance on this line of credit. You will eventually pay more in interest then just a few overdraft charges, being as these LOC interest rates are typically abysmal.  Not to mention if the line of credit is used just once an annual fee is usually charged.

So do you have any other options?

Some financial institutions have a 2nd option for you, called a savings transfer.  In this form of overdraft protection you need a savings account at the same banking institution that you have your checking account with.  The two accounts are linked and when you overdraft on your checking account a transfer from your savings account to your checking account  is automatically made to cover the cost of the overdraft.

This option does not go without its fees though.  Typically a smaller “transfer” fee of around $10 is incurred for overdraft transfers. $10 is much better then $35.

The catch here is that you need money in the savings account that can cover the cost of the overdraft. If you have no money in savings then the overdraft line of credit is the better option.

The best answer for you.

Sure setting up overdraft protection is a great idea for those that have that occasional hic-ups, but overdraft protection should never be a long term solution.  If you are continually facing overdrafts in your checking account month after month learning better money management is the best answer for you.

Learning to keep an active budget and managing your money will save you far more money then overdraft protection.