Overdraft Fee: Everything You Need To Know

Maybe your paycheck didn’t clear in time, or the big purchase you made a few days ago was finally charged to your account. Maybe you just weren’t paying attention to how little money you actually had available.

For whatever reason, you overdrew your account – and now you’re going to pay for it.

The bank doesn’t like it when you spend more money than you have. And for that reason, it may charge you what’s called an overdraft fee.

What Is An Overdraft Fee?

An overdraft fee is charged by your financial institution to cover the cost of an ATM withdrawal or payment that exceeds funds in your checking account. The average overdraft fee charged by banks in 2020 was $33.47.

You may incur an overdraft fee if you write a check to someone and they cash it when you don’t have enough funds in your account to cover the amount. For example, you write someone a check for $100 and they cash it when you only have $80 in your account. It could also happen when you swipe your debit card to pay for something that costs more than the amount of money you have in your account. This often happens when you pay for something small, like carryout, thinking you surely have enough money in your account to cover it. According to a 2014 report from the Consumer Financial Protection Bureau (CFPB), debit card transactions were the leading cause of overdrafts, and most of those transactions were for $24 or less.

How Do Overdraft Fees Work?

When you withdraw money or make a payment from your bank account that’s more than the amount of money you have in the account, your bank will provide a short–term loan to cover the difference, then charge you an overdraft fee. You’ll need to pay back the amount of money the bank covered plus the overdraft fee.

Typically, a bank will automatically cover an overdraft and charge the fee. And if you overdraw your account more than once during the day, not realizing you have insufficient funds, you could automatically be charged multiple overdraft fees. However, you can opt for overdraft protection, which acts as a safety net should you overdraw your account. Overdraft protection allows you to link another account, like a savings account or credit card account, to your checking account. When you overdraft, the bank pulls from the linked account to cover the insufficient funds.

While overdraft protection can help you avoid an overdraft fee, you may still incur a transaction fee for transferring money from one account to another. Terms and services vary per bank, so you’ll need to check with yours to see if it offers overdraft protection and if there are any fees associated with it.

How To Avoid Overdraft Fees

Overdraft protection can help you avoid overdraft fees, but it doesn’t prevent you from overdrawing your account. That issue is even more important to address. The best and easiest strategy to prevent overdrafts is to maintain a positive account balance, plus some cushion. That involves being more aware of and more responsible with your finances. Here are a few tips to get you started:

Sign up for bank alerts. Many banks will send you email or text alerts that will tell you when your account balance falls below a certain amount. When you get those alerts, you’ll know to either transfer more money into your account, use credit or freeze your spending until you can replenish the account.

Review your account often. You should be reviewing your account at least once a week or more, so you’ll be aware of how much money you have and how much you can spend. This can also be a good way to spot unauthorized charges from a stolen card or case of identity theft.

Follow a budget. A budget tells your money where to go. It can create a financial cushion for unexpected expenses and allow you to prioritize your important bills and other expenses. A budget helps prevent overspending by setting certain amounts of money to spend on various categories, like food, entertainment, clothing, etc. Once you spend your allocated amount for that category, you can’t spend any more.

Track your spending. In order to make sure you aren’t going over in any category of your budget, you’ll want to keep track of your spending. Check your account daily and keep your receipts. It may be helpful to record all of your spending as it happens or keep track on a spreadsheet. Some people opt for the cash envelope system, which involves filling envelopes for each category with the allocated amount in cash. Once the envelope runs out, you can no longer spend in that category.

Earn more money or change your lifestyle. The reason you incur overdraft fees is that you’re spending more money than you have. The deeper issue could be that you’re living a lifestyle outside of your pay. To fix this, you’ll either need to change your lifestyle or increase your income.

If the problem is your lifestyle, that may mean cutting back on luxuries, paying off your debt, getting a less expensive car, learning to say “no” and dealing with your FOMO. See where you can trim your budget and make necessary sacrifices.

If the problem is that you just aren’t making enough money, that may mean you need to ask for a raise, change jobs, take on a side hustle or find new streams of income.

Do Overdraft Fees Impact Your Credit Score?

Overdraft fees do not directly affect your credit score or report, but regular overdrafts can be a red flag to mortgage lenders. They show that you may have trouble handling your finances and could have trouble finding enough money to pay your bills.

Also keep in mind that if a financial institution must report unpaid overdraft fees or negative balances to a collection agency, then it will show on your credit score and report.

The Bottom Line

An overdraft fee is what your bank charges you for overdrawing your bank account. When you have insufficient funds, you’ll typically pay around $30 – $35 in overdraft fees, depending on your bank.

The best way to avoid overdraft fees is to set yourself up for financial success by creating a budget and staying up to date on your finances. Education is also key. Want some extra help staying on top of your expenses? You can easily create and track your budget using Rocket Money, now available on mobile app or web. Rocket Money will even scan your expenses for you and negotiate bills to help you save.