Overdraft Line of Credit

A Line of Credit for Your Checking Account

Man walking a tightrope with a safety net
An overdraft line of credit provides a safety net (at a cost). Alberto Ruggieri / Getty Images

An overdraft line of credit is a loan attached to your checking account. If you run out of money, the line of credit (if you have one on your account) can pay for expenses so that you don’t bounce checks, miss payments, or have your debit card denied.

Any money you use is a 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 is 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.

Funds to Keep Paying

It’s always best to spend less than you earn and keep a cushion of cash in your checking account, but sometimes mistakes and surprises catch you off guard. It’s good to have a plan for those situations.

If your 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, for example). 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: yes, people still write 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 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.

Pitfalls

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 are usually dollar limits that prevent you from borrowing too much ($500 or $1,000 total, for example).

Alternatives: again, there are other options. 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.

Example

You have no money in your checking account, but several small charges hit your account: $5, $6, and $7. The total amount you’re short is $18. Your bank may charge 3 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 borrow $18 against the line. Your bank charges you interest on the loan at a market rate (and maybe $5 per item covered). 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 required charge of a few bucks), and you’ll pay $15 in fees.