There are numerous risks to overdraft protection according to The Economic Review David Mengle of the Richmond Federal Reserve Bank. Overdraft payments pose a potential risk to a financial institution if there is no limit to the overdraft protection. Moreover, just because a payment is received via overdraft, does not mean that payment will settle. The settling of payments is a process that occurs after a balance is adjusted and confirms the availability of funds making the original payment more of a notice and less of a confirmation.
In addition to payment risks, having multiple overdraft accounts, or even just one overdraft account, can lead to being charged one or more fees. For example, a bank checking account that has been overdrawn via a bounced check may incur an insufficient funds fee that can be quite high. If multiple checks are written and they all bounce it can result in very high fees very fast. Several factors affect what happens if you withdraw more than you have in the bank, and these factors include type(s) of account(s), bank policy, overdraft program(s), and the amount and type of overdraft. In some cases, overdraft fees can be reduced or eliminated all together.
Automatic overdraft protection
If a bank account has overdraft protection, the overdrawn account will not cause a check to bounce and an insufficient funds fee will not be charged. However, overdraft protection can still lead to additional fees such as balance transfer fees and overdraft fees as well as any interest that may be charged on the overdraft credit. Sometimes these fees may be as high as the insufficient funds fee. In other words, some banks may define overdraft protection as payment of checks for which funds do not exist but still charge an insufficient funds fee.
Credit card overdraft charges
In the case of credit cards that become overdrawn, overdraft, finance fees and interest can be incurred. For example, if one’s credit card balance is near or at the maximum credit limit, and a charge is incurred that places the account balance over the credit limit, extra fees may be charged including interest, overdraft fees, and finance charges. Fees like this can increase the real cost of debt beyond a practical and affordable level, However, a bank can be contacted to eliminate overdraft credit on credit cards to avoid the associated fees. If the credit card doesn’t allow that, avoiding overdraft or not using the credit card may be a viable option.
Account overdraft fees
Depending on the type of account, and which financial institution the account is at, overdraft programs, arrangements and fees may vary. For example a checking account with overdraft protection may incur a line of credit interest charge and an overdraft protection using a balance transfer may incur a balance transfer fee. The fees and overdraft mechanisms that influence overdraft include insufficient fund fee(s), finance charge(s), interest fee(s), balance transfer fee(s), and line of credit fee(s).
Overdraft tips and techniques
As mentioned above, different options exist when it comes to account overdrafts. For example, The Federal Reserve Bank offers some important suggestions that can help prevent being charged overdraft fees. Some fees cost more than others, and some overdraft services are more helpful to the account holder than others. In some cases, overdraft alternatives may be more cost effective, while in other cases, the overdraft options may be worthwhile. Essentially, paying attention to what costs more and lowers your bank account balance the most is important if you withdraw more than you have in the bank. Below are a few methods that may help in reducing and/or avoiding the costs of bank account overdraft.
1. Multiple account closings: Wait until the last interest payment is received from savings’ accounts before closing a checking account, then close the checking account before monthly fees become due.
2. Credit cards: Ask your bank if you can remove overdraft protection and fees from your credit card
3. Compare fees: When an overdraft is inevitable, find the cheapest source of financing ex. If the overdraft fee is higher than the fee and interest on a fast cash loan, or a credit card, consider going with the lowest.
4. Overdraft options: A tiered system can add fee protection. For example, set up a transfer balance option and a line of credit. If no balance exists for the transfer, the line of credit takes effect. Both options avoid insufficient funds and/or bounced check fees which can be a more expensive option.
5. Budget: Making a budget and keeping track of money can help balance funds and assist in avoiding the need for overdraft.
6. Timing: Knowing when funds become available and when withdrawals take place can be important in avoiding overdraft. This may involve paying bills over a monthly spread rather than all at once so that sufficient funds are available when they are paid.