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What is overdraft protection and how does it work?

Overdraft protection typically allows transactions exceeding the balance in your checking account to be approved and can save you steep overdraft fees. Here's how it works.

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If you spend more money than you have in your checking account and end up with negative balance, your bank or credit union may cover the payment and charge you an overdraft fee.

Overdraft fees cost up to $35 and are one of the most expensive and common checking account fees, since you can incur multiple overdraft fees in one day. The limit on overdraft fees varies by bank/credit union, but many cap it at four per day.

Some banks offer overdraft protection, which can help you avoid fees each time your bank or credit union authorizes transactions greater than your available balance. 

CNBC Select explains how overdraft protection works, and we offer some tips on how to avoid overdraft fees.

What is overdraft protection?

Many banks and credit unions provide the option to enroll in overdraft protection, also known as overdraft coverage/service. When you opt into this service, the additional money you need to cover a transaction will be transferred from a linked bank account, typically a savings account, but you could also link a secondary checking account, credit card or line of credit. While you may still incur a fee for the transfer, it's often less than the overdraft fee.

For instance, the Bank of America® Advantage Plus Banking account charges a $12 fee per transfer from a linked bank account, which is less than the $35 overdraft fee. And if the transfer is less than $1, there are no fees. 

However, there are checking accounts that don't charge savings account transfer fees after you opt-in, such as the Capital One 360 Checking® Account and the Discover Cashback Debit Account.

If you sign up for overdraft protection, but ultimately decide it's not the best service for your needs, you can opt out at any time. 

How to avoid overdraft fees?

The simplest way to avoid overdraft fees is to maintain a positive account balance at all times. Regularly check your account balance, and if you pay certain bills (such as your credit card) by autopay, make sure you have enough to cover the cost before the bill is paid each month.

You can also consider opting-in to your checking account's overdraft protection, but do your research to see if there are fees associated with it. If your bank or credit union charges a fee for transferring money from a linked bank account, consider switching to an account that has no overdraft fees.

The Capital One 360 Checking® Account offers three overdraft settings, and two options have no fees.

  1. Auto-decline: Capital One generally declines transactions that are greater than the balance in your account and won't charge a fee.
  2. Free savings transfer: Capital One will transfer available funds from a linked savings or money market account to cover overdrafts at no additional cost.
  3. Next Day Grace: Capital One authorizes transactions that exceed the balance in your account, and you'll have until the end of the next business day to make your balance positive, or you'll incur a $35 fee.

For all options, bounced paper checks (which occur if you write a check and don't have enough money in your bank account to cover the amount) incur a $9 insufficient funds (NSF) fee.  If you want to minimize overdraft fees, consider the auto-decline or free savings transfer options.

There are some checking accounts that don't charge any overdraft fees whatsoever, such as the Discover Cashback Debit Account. This is one of CNBC Select's best no-fee checking accounts, and it doesn't charge many of the fees other checking accounts do, such as monthly maintenance fees or bounced check fees. If you make a transaction without enough money in your account, Discover will decline it unless you enroll in overdraft protection (which is free) and have enough funds in a linked account. 

Overdraft protection, how it works and the related fees differ some from bank to bank, and it can be confusing. It's important to make sure you understand the terms and fees connected to your account, before you opt-in. In addition to regularly monitoring your balance and signing up for overdraft protection, set up alerts with your bank or credit union that notify you if your balance is running low. This can help you avoid overdrawing your account and potentially save you on steep overdraft fees.

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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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