Overdraft Line of Credit
An overdraft line of credit is a loan attached to your checking account. If you run out of money and you've been approved by your bank for this type of add-on, the line of credit can cover expenses so that you don’t bounce checks, miss payments, or have your debit card denied. Some banks also allow you to access the line of credit if you need emergency cash.
Any money you use is provided as a standard loan from your bank, so you’ll pay interest on the amount you borrow. However, overdraft lines of credit are often less expensive than traditional overdraft protection programs, which usually charge around $35 for each rejected transaction that hits your account.
An overdraft line of credit offers one option for overdraft protection, but there are other choices. Remember that overdraft protection is optional so you don’t need to add anything to your account, but your bank might still charge fees even if you’ve never opted in to receive overdraft coverage.
Penalties Without Overdraft Protection
It’s always best to keep a cushion of cash in your checking account, but sometimes mistakes and surprises catch you off guard, and it's good to have a plan for those situations. If your checking account runs dry, the outcome will depend on the types of charges that hit your account, and how your account is set up.
- One-Time Debit Card Transactions: If you use your debit card for day-to-day shopping or ATM withdrawals, your bank might simply reject the transaction as long as you never opted in to any kind of overdraft protection like an overdraft line of credit. In that case, you can use a different payment method or simply do without. However, if you’ve opted in to some sort of overdraft protection, you’ll use that service.
- Preauthorized Payments: Recurring monthly bills that hit your account by ACH will most likely still be processed by your bank, even if your checking account is empty. In those cases, you’ll either pay a fee for insufficient funds, again, often around $35, or you’ll use some form of overdraft protection.
- Checks: If you write a check for more money than is available in your account, your bank might or might not allow the check to go through. Again, if you have regular overdraft protection, it will cover the check as long as the amount is within limits. If not, your bank might allow the check to bounce, resulting in numerous fees and headaches.
An overdraft line of credit is less expensive than traditional overdraft protection, and it allows you to keep spending in emergencies. But it’s dangerous to rely on any form of overdraft protection. Your bank will eventually cut you off if you use it too often, and you’ll pay more in fees than you need to. It’s best to balance your account and sign up for alerts, so you know if you’re running low on funds.
- Cost: Overdraft lines of credit, while inexpensive, are not free. You’ll have to pay interest on money you borrow. If you only borrow for a day or two, the cost should be extremely low. But you might also have to pay a small fee every time you dip into the overdraft line of credit, so the more you use it, the more it’ll cost you. The per-occurrence fee might be around five dollars. Finally, some banks charge a modest annual fee to keep the service on your account.
- Limits: There usually aren’t any strict limits on how many times you can use an overdraft line of credit, but banks get uneasy about customers who use it too often, and they might eventually close your account. There is usually a dollar limit on the line of credit to prevent you from borrowing too much. Depending on your credit and potential need, you may secure an overdraft line of credit for $500 or $1,000, although some banks offer lines with a credit limit of up to $10,000.
- Alternatives: If your main risk is overspending with your debit card, you can simply opt-out of overdraft protection. Your bank will reject your card, and you can find another way to pay. Your bank might also allow you to set up a transfer from your savings account—instead of borrowing the bank’s money you’ll use your own cash. The fee for a savings transfer is generally similar (you can set it up, so your savings account gets used before you borrow from a line of credit).
Getting an Overdraft Line of Credit
To sign up for an overdraft line of credit, contact your bank. Be sure to ask about all of the alternatives, such as a savings account transfer, and get familiar with the fees. Once it’s on your account, use it as little as possible.
Let's say you have no money in your checking account, but several small charges hit your account: $5, $6, and $7. You're short for a total amount of $18. Your bank may charge three overdraft coverage fees of $35 each, one for each item. That’s $105 in fees to cover $15 in charges.
With an overdraft line of credit, you'd borrow $18 against the line. The bank charges you interest on the loan at a rate comparable to credit cards, and possibly a fee such as $5 per item covered.
If you repay the loan within a few weeks when your paycheck hits your checking account, the interest charges might be less than a dollar, or some minimum charge of a few bucks. Thus, you’ll pay $15 in fees instead of $105, as you would have with standard overdraft protection.