Overdraft protection is a service implemented by financial institutions to give customers a form of credit, where the bank would cover any payments on withdrawals from an account that had dipped below a zero balance. While this might seem like a useful service in times of an emergency, many people have argued that overdraft protection was a ploy for banks to profit from their customers' poor money management and spending habits. Here is a look into overdraft protection to help you determine if it is worth having for your checking account.
Automatic Enrollment for Overdraft Coverage
At one time, a bank could automatically enroll its customers in overdraft coverage without their consent as a type of courtesy service. This became known as "overdraft coverage," "bounce protection" or "overdraft privilege" amongst many financial institutions. This meant that anytime a customer tried to withdraw money from his or her checking account, whether it was through an ATM, debit charge or written check, the withdrawal would be honored and paid for by the bank. However, the customer would then be charged a fee for this service and any other subsequent times money was withdrawn from a checking account with a balance of zero.
In other words, if you unknowingly withdrew $6 for lunch from your checking account, your lunch would cost you $36 with the additional $30 from overdraft protection. If you paid for a $20 grocery bill, that's another $30 overdraft protection charge, brining your groceries bill to $50. On many occasions, bank customers would not know they were being hit with overdraft fees until after they had been charged several times. In fact, many people were completely unaware that they had enrolled in some type of overdraft protection plan to begin with.
In order to protect consumers, federal regulations were implemented that required a customer's consent, or opt-in, for overdraft protection services from his or her financial institution. That meant that customers not enrolled in overdraft protection services, would have any debit payments or cash withdrawals denied. Because of this, many banks began marketing overdraft protection plans or services.
What Is the Difference Between the Old Overdraft Coverage and Overdraft Protection?
The old form of overdraft coverage that did not require a customer's consent would impose a hefty charge of anywhere from $25 to $35 to cover an overdrawn checking account. With federal regulation requiring a customer's consent for overdraft protection, banks began marketing overdraft protection plans:
- Overdraft protection with a savings account: Some banks offer overdraft protection through a savings account that is linked to your checking account. Overdraft protection will automatically arrange for money to be transferred from your savings account to cover money withdrawn from your checking account. A service charge may be imposed for the transfer of funds, but these fees tend to be lower than the old overdraft coverage charges. Interest isn't owed on money transferred, although the money removed from the savings account is no longer earning interest.
- Overdraft protection with a credit card: Other banks will allow you to sign up for a credit card to be used for overdraft protection. Rather than funding you the money or transferring it from a savings account, the bank will place a cash advance on the credit card to cover the overdraft. What you have to pay may vary with interest owed and any cash-advance or service fees.
Is Overdraft Protection Worth It?
One of the advantages of overdraft protection is that you can count on having money for emergency situations, like if your car breaks down in the middle of nowhere. Overdraft protection will also allow you to avoid bounced checks where you might be charged by both your bank and the business you issued a payment to. Avoiding bounced checks and late payments can also help you protect your reputation.
However, many people feel that overdraft protection plans aren't worth the money. With good money management, you can avoid the possibility of an overdraft all on your own. Electronic alerts in the form of mobile text messages or emails can help you maintain a checking account balance that won't get you into trouble. This will also allow you to avoid overdraft protection fees and bad spending habits that can get you into financial trouble.
It's up to you to decide if having a safety net in the form of overdraft protection is worth all the fees. If you are living from paycheck to paycheck, it might be worthwhile to have overdraft protection to help you during times of emergency. However, proper money management negates the need for overdraft protection all-together.