Monday, 16 July 2018

The only thing worse than realizing your checking account balance is hovering near zero is realizing your balance has dipped below zero and you've overdrawn your account.

When you overdraw your account, you can rack up all kinds of fees from your bank and the merchant who declined a debit transaction or returned a check. One way to avoid that is to sign up for overdraft protection.

Overdraft protection can provide a safety net for anyone, but it's especially valuable for someone opening a first checking account or for those who don't keep a high balance and can't afford extra fees or missed payments. While you don't want to rely on overdraft protection to make it from payday to payday, it can be a smart financial tool when managed carefully and used responsibly. 

How overdrafts happen

According to a 2014 publication by the Consumer Financial Protection Bureau Office of Research, overdraft and NSF fees make up the majority of checking account fees American consumers pay each year. Younger consumers, ages 18-25, have more annual overdrafts than any other age group. What's more, the dollar amount of transactions triggering overdrafts tends to be rather small, with $24 as the median amount of debit card purchases leading to overdrafts.

Overdraft frequency tends to decline with account-holder age, with 10.7 percent of the 18-25 age group having more than 10 overdrafts per year, compared to only 2.8 percent of the 62-and-over age group, according to the publication.

Most banks charge overdraft fees that can range from $15 to $40 per check or transaction. You may even face multiple fees in a day if there are several outstanding charges or checks to be paid.

For example: You write a $20 check for groceries and then buy a $5 cup of coffee with your debit card, but your account balance is only $17. The $20 check overdraws your account, the $5 purchase will "bounce" as well. Let's say your bank's overdraft fee is $35 per non-sufficient funds (NSF) transaction—that's $70 in fees just from the bank. On top of that, the grocery store and coffee shop can also charge you a fee, leaving you on the hook for more than $100, and that's before you've actually even paid for the groceries and coffee.

You may wonder how you could buy the coffee with your debit card if the check drained your account. Depending on your bank and specific checking account, some purchases will be paid even if there are no available funds. And some checks may post immediately, while others may not clear for a day or two. 

How does overdraft protection work?

Banks offer several kinds of overdraft protection to ensure your checks and card transactions will go through even if you do not have enough money in your account. There are three widely used ways to provide overdraft protection:

  • Link to savings. You could link your checking account to a savings or other account you have at the same bank. The bank would be authorized to transfer funds from your savings to checking in the event you overdraw your account and charge a small fee per incident. 
  • Get a line of credit. Some banks, including BBVA, offer customers an overdraft protection line of credit. If your account is overdrawn, checks or ATM/debit card transactions would be paid using funds from your line of credit. There is a fee for each transaction, and you'll pay interest on the balance of your line of credit. This method requires credit approval.
  • Opt in for courtesy overdraft protection. In this scenario, your bank would pay checks and card transactions, at the bank's discretion, when you account is overdrawn and charge you a fee. The coverage usually incurs a fee anywhere from $12 to $38 per day or per instance, depending on the bank—but the key point here is that your purchases will go through, and you won't be charged  an insufficient funds or late payment fee by the merchant. 

How to Avoid Overdraft Fees: 5 Easy Tips

The best way to not pay fees, however, is to avoid overdrafts altogether. Here are a few ways to do that, even if you have overdraft protection:

  • Check your balance daily, and use online banking tools to help you understand where your money is going. 
  • Set a phone or email alert to let you know when your balance is low. 
  • Use mobile and online banking to make deposits and transfers quickly. 
  • Use direct deposit so your paychecks go immediately into your account.
  •  Use a pre-paid debt card or a secured credit card

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