Overdrafts occur when an account has insufficient funds to cover a transaction, but the bank allows it to go through anyway.
In simple terms, overdrafts allow customers to take out a loan for a set amount. However, doing so comes at a cost. You will be charged interest on the loan, and there is typically a fee per overdraft. Overdraft is excellent if you need to borrow money for the short term and will immediately pay it back.
Overdraft fees are charged when the account goes into the negative and Overdraft Privilege (ODP) is active in the account. ODP covers the cost of a transaction in the event a checking account doesn’t have sufficient funds.
As an example, if there is $200 in a bank account and a $250 purchase is made, the account would be overdrawn by $50. The account balance would then be -$50. The $50 would then need to be paid back along with an overdraft fee and any interest charges. Banks take the repayments out of the following deposit.
What is overdraft protection, and how does it work?
Some banks will pay overdrafts automatically. This is known as overdraft protection. For a fee, overdraft protection prevents overdrafts from affecting your account or credit. It is important to note that overdraft is optional.
Typically, this process works by linking your checking account to a savings account, another checking account, or a line of credit. If a shortfall occurs, the funds are taken from the linked account or line of credit. This ensures cheques aren’t returned and avoids declined transactions or transfers. It also avoids triggering a non-sufficient funds (NSF) charge.
The amount of overdraft protection provided changes depending on your account and bank. Overdraft protection typically needs to be requested to be activated. However, there are cons on top of the pros associated with overdraft protection. It’s important to remember that fees are attached to these services.
This tool shouldn’t be used recklessly, and only in an emergency. If the overdraft protection is used excessively, the bank may remove it from the account.
With overdraft protection fees, you’ll still pay interest on the overdrawn balance. Depending on the fee option, there will also be a flat monthly fee or a fee per overdraft.
Each bank has different terms and conditions to abide by when using overdraft protection. Be sure to educate yourself before using this tool.
What are non-sufficient funds?
An NSF fee is charged when an account doesn’t have enough funds to cover the amount of a transaction. The transaction is deemed unpaid and the account holder is charged an NSF fee. NSF only occurs if the account does not have ODP active, if the account exceeds transfer limits, or if the account exceeds the negative $750 limit.
If your account exceeds the negative $750 limit or exceeds your transfer limit, you are charged a $25 NSF fee. Fee descriptions on bank statements will be specific to the transaction.
Here are some examples of fee descriptions that might show up on the right of a transaction on a bank statement:
- Overdraft – Debit ODP fee
- Overdraft Fee – Cheque ODP fee
- Unpaid Ck #… – Unpaid (NSF) Cheque
- Unpaid ACH – Uncleared/Unpaid ACH item
Will an overdraft affect your credit score?
Overdrafts will begin to affect your credit went they are sent to collections. if all the fees and negative balance are paid after an overdraft by the due date then there’s no issue. However, the bank can send the debt to collections if you do not pay back what you owe. After a debt reaches a collection agency, an account is created. At this point, the debt is indicated on your credit report as delinquency and remains there for up to seven years. That is why it is essential to pay back overdrawn balances and fees as soon as possible.
How to avoid using overdraft protection?
The most common overdraft fee for most bank accounts is $35. There can also be additional fees added to that. To avoid wasting money on these fees, here are some tips you can follow:
Balance your chequebook
Always keep track of your balance, transactions, and automatic payments. Luckily with the advancement of technology, this is easier than ever. You can sign onto online banking or use an app on your phone to monitor your account and ensure they are in check. A vigilant eye on your account will help you avoid overdraft fees. This will also inform you how much money is in your account, preventing bounced cheques and detecting possible errors.
Pay with cash or use a debit card
When using cash or a debit card, you don’t have to worry if a payment will clear. This isn’t the case when you use a cheque or credit card. People often forget that they have written a cheque and then spend the money in the account needed for the cheque to clear.
Create an artificial buffer
Keep an additional sum of money in your checking account, just to be safe. Determine how much will need to always be in the account and never dip into it. Subtract that amount out of your chequebook so that the balance you see is how much you can actually spend.
Use direct deposit
You are given instant access to your money by using direct deposit for your paycheque. Also, you don’t have to worry about cashing your cheque.
Link your checking account to another account
Link your checking account to a home equity line of credit (HELOC) or a money market. This will ensure that if you overdraw your checking account, money will be taken out of the other account it is linked to, preventing a bounced cheque.
Conclusion
An overdraft can be an invaluable tool to prevent bounced cheques or the embarrassment of a declined card. However, if not monitored, it can cost a lot of money and possibly affect your credit score.
If you’re already overwhelmed by overdraft fees and interest the team here at Consolidated Credit can help. Contact us today to get started.
