Overdraft

Overdraft summary: 

• Overdraft means a withdrawal (a draft) for more than the balance in your account.

• If your bank or credit union allows the transaction, your account will end up with a negative balance. That’s an overdraft. 

• Most financial institutions charge fees for overdrafts, and the fees can be costly. 

Overdraft definition and meaning

Overdrafts happen when there isn't enough money in a checking account to cover a transaction but the bank pays it anyway. This means the account balance is negative. 

Key concept: A checking account balance that goes negative when there isn't enough money to cover transactions that the bank allows to go through.

More about overdrafts

Overdrafts take place when there isn't enough money in a checking account to cover one or more transactions. The transactions could be debit card purchases, ATM withdrawals, checks, or automatic payments. When you open a checking account, you can choose whether to allow certain kinds of overdrafts or not. 

If overdrafts aren’t allowed, most transactions will fail. It won't be possible to withdraw money or make purchases with a debit card when there isn't enough in the account. Checks written on overdrawn accounts will probably bounce. Checks returned for insufficient funds may incur fees. Some automatic transactions could still go through, resulting in an overdraft and fees.

Not allowing overdrafts could help you avoid the fees and the hassle of having a negative account balance. However, it can be embarrassing if the transaction is declined at a restaurant or check-out counter, or cause real hardship if you can't buy gas or food when you need it. 

If overdrafts are allowed, the transaction will go through as long as the negative balance doesn't exceed an overdraft limit set by the bank

Key concept: An overdraft is a withdrawal that exceeds your account balance. 

Overdrafts: a comprehensive breakdown

Overdraft fees can get people into trouble quickly. Banks can charge fees for every transaction and for every day the customer doesn't make a deposit to bring the balance above zero. Some banks reorder transactions in a way that maximizes these fees. 

Suppose that your balance is $100 and you have three debits: $20 for lunch, $75 for a haircut and $110 for a new jacket. And assume your bank charges $40 per overdraft. If the transactions were processed in order, you'd have been able to cover the first two charges. The last one would put you in the negative, and you’d be charged an overdraft fee. 

But some banks reorder the transactions: they process the $110 charge first and add an overdraft fee. Then, with the account already overdrawn, the bank pushes the next transactions through. This reordering would cause you to owe $120 in overdraft fees instead of $40. 

How to avoid overdrafts

The easiest way to avoid overdrafts is to keep an eye on your bank balance and know how much is in there. Checking your balance and activity online or on your phone can help you stay on top of the details. Keep an eye on your pending transactions

You might be able to link a savings account or credit card to your checking account, and the bank can transfer money if you come up short. Some banks don’t charge a fee for this. Others do, but it’s often less than the cost of a standard overdraft fee.

You could also consider putting all automatic payments on a credit card instead of your checking account. Then pay the credit card from your checking account at the end of the month. Use a free budgeting app