Overdraft Protection Mechanisms
If you do not have the funds in your checking account to cover a specific transaction, the bank may cover it on your behalf in some cases and charge you an overdraft fee. If you enroll in overdraft protection, the bank will still approve the withdrawal with your debit card, allowing you to complete the purchase. However, your account will be overdrafted at this point, meaning you have a negative balance in the account. The bank will charge an overdraft fee and will require you to deposit funds immediately to cover the required amount. If you do not enroll in the service, the bank will decline the transaction and will not charge you an overdraft fee.
Advantages and Disadvantages of Overdraft Protection
The main benefit of overdraft protection is that it helps you cover emergency expenses even if you are experiencing a cash flow shortage. You can also avoid penalties or fees that would have applied if a payment was delayed due to temporary financial issues. Additionally, you can avoid bounced check fees from merchants, provided you pay by check and it is allowed to be collected. The recipient of the payment will not be aware that you have a cash shortage when you pay them. This helps you avoid embarrassment, especially if you are sending payment to a friend or business partner.
Cost of Overdraft Protection
Banks typically do not offer overdraft protection for free. They charge a fee to prevent you from abusing the service, as it represents a source of revenue for the bank. Banks charge different fees for overdrafts; however, there is a standard fee for each transaction, which is around $35. Banks may also impose different limits on the amount of cash covered by the overdraft protection service. Be sure to understand the potential fees before enrolling in overdraft protection.
Reducing Fees
As you may have guessed, the best way to avoid overdraft fees is not to enroll in the service, which can often prevent overdraft fees from being charged. However, if you intend to enroll in an overdraft protection program, compare different banks to reduce your costs. Get answers to some key questions to find the bank that offers the most affordable overdraft protection service: What are the overdraft fees? Based on this figure, consider the frequency of overdrafts you experience to determine whether the service will cost you less at one bank compared to another. Can you link your checking account to a backup funding source that will be used before the overdraft feature? If you connect a savings account for cash withdrawals, for example, you may be able to avoid overdraft fees and interest costs. Will the overdraft plan be more beneficial? Ask your bank about the fees that will apply when using the line of credit and what interest rate you will pay on the money you borrow.
Legality of Overdraft Fees
In July 2010, federal law changed regarding how banks and credit unions charge overdraft fees. Previously, banks automatically added overdraft protection to your account, and you often had to opt-out of this “protection.” As a result, consumers paid fees to banks due to simple errors in their checking accounts. A common example was a $38 coffee – $3 for the coffee and $35 for the overdraft fee. Banks were required to stop the overdraft feature and only offer it to customers who opted into the service, but customers still faced overdraft fees in some cases without enrolling in the service. Two situations can lead to unexpected overdraft fees: either the bank is violating the law and charging illegal fees to customers, which is unlikely but not unheard of, or the purchase is not one of the “one-time” payments covered by the overdraft law. You can argue whether the law should define the concept of overdraft more broadly. However, understanding how overdraft protection works under current law can prevent you from paying overdraft fees for transactions that are not covered.
Source:
https://www.thebalancemoney.com/overdraft-protection-plans-315312
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