What Is Overdraft Protection?

Overdraft Protection, Cash Reserve Accounts and Other Banking Services

Overdraft protection can stop you from overdrawing your account.
Sam Edwards/Caiaimage/Getty Images

You need to be aware of the overdraft policies at your bank. Banks vary in what they call overdraft protection and a cash reserve account. The differences in the costs of theses services can be huge. You need to fully understand what your bank is offering as well as what happens if you were to overdraw at your bank.

What Happens When I Overdraw My Account?

Some banks will not allow you to go into the negative.

This means that they will not pay on an item that will take you into the negative. However, that does not stop them from charging you a fee for having a returned item, which will put into the negative. Generally, a returned item fee is between $25.00 and $40.00. Additionally, you may receive another fee for allowing your account to go into the negative. You may be charged this fee on a daily basis. If they do not pay the cost, you will also incur a fee from the business that tried to cash your check.

What Is Overdraft Protection?

Some banks offer a type of overdraft protection. It was a variety of names: overdraft protection is the most common. This means that the bank will allow you to overdraw your account up to a certain amount, and they will still pay the checks or debits. You will be charged a fee per item that they pay. The fee is similar to the returned item fee. However these fees add up quickly.

For example if you are overdrawn, but then have two items present one for $5.00 and the other for $10.00 you would be charged the $30.00 fee twice. This means your $5.00 purchase actually cost you $35.00 and your $10.00 purchase cost you $40.00. Once you get started in this cycle it is difficult to get out of it.

What Is a Cash Reserve Account or an Overdraft Account?

Another option is an overdraft account or a cash reserve account. This is a line of credit that is attached to your checking account. When you overdraw the bank will transfer the money into your account to cover the negative balance. There is usually a fee of a few dollars per transfer. Your bank may transfer in increments of $50.00 or $100.00. Additionally, you pay interest on the money that you have transferred over. This is a much better option than overdraft protection. You would need to apply to receive this account, just like you do with a credit card. You should talk to an account representative at your bank to see if they offer this account.

What Is a Overdraft Transfer Option?

Finally, some banks and credit unions may give you the option to tie one of your accounts to your checking account to use in case you overdraw your account. This is the best option, because the transfer fee is small, you do not have to pay back the money to the bank and you save in interest charges and returned check charges. However it can be dangerous because you can eat through your savings. You should have a small amount in the savings account you have tied to your checking account.

A good amount would be about $1000.00. This should be able to handle most minor mistakes. You should keep your emergency fund in a different account in order to save it for true emergencies.

How Do I Avoid Overdrawing My Account?

While it is nice to have the overdraft protection, you should avoid overdrawing at all. You can do this by balancing your checkbook, keeping a running total and checking the balance at your bank to see if you have missed any debit charges you have made on a regular basis. These simple little steps can save you a lot of money if you take the time to do them consistently. Attention to detail will help you avoid most common financial mistakes.