What is overdraft protection?

How overdraft protection works

Overdraft protection is the arch enemy of a bank’s “bad boy fees.” Understanding this statement is based on your understanding of two basic rules of contemporary banking:

• Banks will never encourage you to overdraw your checking account.
• Banks often don’t mind if you do, since they make income on “bad boy fees” (NSF charges) they apply when you do overdraw.

Overdraft protection, which can take more than one form, allows you to keep your checking account with a positive balance, even if you “miscalculate” a bit and write checks, make withdrawals, or Internet transfers that put your account in a “red” (overdrawn) condition. The most popular methods of creating overdraft protection:

• Establishing an unsecured loan agreement with your bank that provides for the generation of a loan whenever you overdraft your account for the amount of the shortfall.
• Establishing an agreement that states whenever your checking account balance travels to the “red zone,” your bank will access another account you have to auto transfer the monies needed to bring you to at least a zero balance, eliminating the overdraft.

Without overdraft protection, your account will typically be charged around $20 to $35 for every item that creates an overdrawn condition. This means that if you wrote four checks that created and/or expanded an overdraft, you might be charged between $80 and $140.

While you will also normally pay a fee for overdraft protection (either a few days interest on a personal loan or a small fee to transfer from another account), the bad boy fees charged are much higher and produce more income. Having overdraft protection is definitely the preferred way to handle this potential problem.