What is an overdraft and why should you avoid it?

This type of service offered by banks and credit unions prevents you from going through embarrassing situations due to financial difficulties, although they have an extra cost.

An overdraft is the term that explains when you make a transaction that exceeds the funds you have available in your account and for which the bank or credit union covers the cost of your purchase. Although this does not apply to all bank accounts, you should be careful how you use your money through a debit card, because you would run the risk of overdrawing it and, with it, paying more money for extra charges.

Although an overdraft is a service that allows you to be calm about making any purchase or transaction with your debit card from your bank account without worrying about being rejected due to a lack of money in your personal balance, it also generates a fee and you could even have extra charges in the form of interest for the funds used, which act as a loan made by your financial institution.

How does an overdraft work?

An overdraft occurs when you do any of the following on your bank account:

  • Purchases with your debit card in person or online and are approved, even if there is not enough money in your account to cover the cost of your transaction.
  • An automatic payment charged to your account is deducted when you don’t have enough funds to cover the cost.
  • You write a check that is deposited and deducted from your account later than expected, at the exact moment when you do not have funds available to cover that payment.

According to a warning from The Balance, more often than not, a bank or credit union will base the overdraft on your available balance — the amount of money in your account that you can spend, withdraw, or cover transactions. Sometimes your listed balance is different from your available balance, so be sure to check your available balance and what the bank really thinks you can spend.

Overdraft Fees

Fees vary by bank or credit union. However, the average cost of an overdraft fee is $35 per occurrence, according to the Pew Center on the States. The analysis notes that even with overdraft protection involving an automatic transfer, a fee may still be incurred. Pew reports that it is common to see a fee of around $10 for these transfers, although not all banks charge this fee.

You should also be careful because some banks and credit unions classify overdraft protection as a line of credit. If so, you could end up paying interest on the overdraft amount until you pay the amount advanced by your financial institution.

Before opening your bank account, check with the financial institution what its overdraft protection is.

  • There are institutions that have standard protection, this means that it covers certain transactions such as automatic payments, recurring debit purchases, payment of memberships or subscriptions.
  • Another type of protection available is to link a savings account to your checking account as a form of fund backup. When the overdraft occurs, money is automatically transferred from the linked account and deposited into the transaction account. There are institutions that offer you this service for free and others may charge you a fee.

From the contracting of your bank account, review the protections and fees for overdraft. To avoid any extra charges to your bank account, it is best that you manage your budget better and be clear about how much money you have in your bank account to avoid spending more of those funds and risking an overdraft.