Overdraft

Also called Overdraft fee, Overdraft protection

What happens when a transaction takes more money than your account holds, which can lead to a fee, a declined payment or a transfer from savings.

What it means

An overdraft occurs when a purchase, check or withdrawal exceeds the available balance. The bank may cover the shortfall and charge an overdraft fee, decline the transaction, possibly with a returned-item fee, or pull money from a linked savings account or credit line, often called overdraft protection, sometimes for a smaller transfer fee.

Under federal rules, banks cannot charge overdraft fees on ATM withdrawals or one-time debit card purchases unless you have opted in to that coverage. Checks and automatic payments are handled under the account agreement. Fees, daily caps and grace policies differ widely, and some institutions have dropped overdraft fees altogether.

Example

For example, if an account holds $50 and an $80 bill payment goes through, the balance becomes negative $30. If the bank then adds a $35 overdraft fee, the customer owes $65 before the next deposit, all for a $30 shortfall.

How it’s used

Deciding whether to opt in to debit card overdraft coverage
Linking savings to checking to avoid declined payments
Comparing banks on fee policies

Strengths and weaknesses

Strengths

Coverage can keep an important payment from bouncing
Linked-account transfers are usually cheaper than overdraft fees

Weaknesses

Fees can be very expensive relative to the shortfall
Several fees can stack up in one day
Repeated overdrafts can lead to account closure

Good to know

Low-balance alerts and a small cushion in checking can prevent most overdrafts.

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.