An overdraft happens when your bank allows a payment to go through even though there isn’t enough money in your checking account. Instead of declining the transaction, the bank temporarily covers the cost for you. In simple terms, an overdraft is a short-term loan from your bank.
While overdrafts can help you avoid declined payments or bounced checks, they often come with fees and interest, which can add up quickly if you’re not careful.
How Overdrafts Work in Real Life
Imagine you have $20 in your checking account, but a $45 phone bill is charged. If overdrafts are allowed on your account, the bank may approve the payment anyway. Your balance then becomes –$25, and the bank charges you an overdraft fee for covering the difference.
Many banks charge a flat fee per overdraft, sometimes as high as $30 or more per transaction. Interest may also apply until you bring your account back to a positive balance.
Why Banks Allow Overdrafts
Banks offer overdrafts as a convenience. Instead of rejecting payments and causing late fees from merchants, they step in and cover the shortfall. However, this service isn’t free. Overdraft fees are a major source of revenue for many banks.
In some cases, overdrafts can be cheaper than using a credit card for a very short period—but only if you pay the balance back quickly.
Overdraft Fees: What You Need to Know
An overdraft fee is what the bank charges you for covering a transaction when your account balance is too low. This fee is usually charged each time your account goes negative.
For example:
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One overdraft might cost $30
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Three small transactions in one day could mean $90 in fees
That’s why overdrafts can become expensive fast, especially for small purchases.
What Is Overdraft Protection?
Overdraft protection is an optional service that helps prevent transactions from being declined or checks from bouncing. It usually works by linking your checking account to:
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A savings account
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Another checking account
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A line of credit or credit card
When your checking account doesn’t have enough money, funds are automatically transferred from the linked account to cover the transaction.
Example
If your checking account is short $50 and it’s linked to your savings account, the bank moves $50 from savings to checking. You may still pay a transfer fee, but it’s often lower than a standard overdraft fee.
Is Overdraft Protection Free?
No. While it can save you from declined payments, overdraft protection typically comes with fees. Banks may charge per transfer, and if a credit card or credit line is used, interest can apply.
Because of these costs, overdraft protection is best used occasionally, not as a regular financial strategy.
Can Overdrafts Affect Your Credit?
It depends on how the overdraft is handled:
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If the bank covers the overdraft with its own funds and you repay it quickly, your credit score is usually not affected.
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If the overdraft is linked to a credit card or credit line and balances grow, it could impact your credit.
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If you fail to repay an overdraft and the account goes to collections, it may be reported to credit bureaus and harm your credit score.
Important Warnings About Overdrafts
If an overdrawn account stays negative for too long, the bank may:
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Close your account
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Send the debt to collections
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Restrict or remove overdraft privileges
Regulators have also found that some banks charged unfair overdraft fees in the past, leading to refunds and policy changes. Still, customers should stay alert and review account statements carefully.
Pros and Cons of Overdrafts
Pros
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Prevents declined transactions and bounced checks
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Helps during short-term emergencies
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Can be less embarrassing than a returned payment
Cons
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High fees for small mistakes
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Easy to rely on too often
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Can lead to debt or account closure if mismanaged
Studies have shown that people with overdraft protection often end up paying more fees overall, not less.
Smart Tips to Avoid Overdrafts
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Keep a small buffer in your checking account
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Set up low-balance alerts
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Track upcoming bills and automatic payments
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Consider opting out of overdrafts if fees are a concern
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Use overdraft protection only as a last resort
The Bottom Line
An overdraft lets your bank temporarily cover a payment when your account runs out of money. While it can be helpful in an emergency, overdrafts often come with costly fees and interest that can quickly strain your finances.
Overdraft protection can reduce some risks, but it’s not free—and it shouldn’t replace good money habits. The best way to avoid overdraft trouble is to monitor your balance closely and keep spending aligned with what’s actually in your account.
