Understanding Overdraft Fees

Overdrafts occur when you do not have enough money in your account to cover a transaction, but your bank pays it anyway. Learn how overdrafts occur and services your bank may provide in the event you overdraw your account.

What Is an Overdraft?

An overdraft occurs when you do not have enough money in your checking account or money market account to cover a transaction, but the bank pays it anyway.

Depending on your needs, your bank’s overdraft service can provide a useful benefit. For example, it can save you the frustration of having a purchase declined and can help cover important bills. However, it’s important to remember that overdrafts may also come with fees, and how those fees are charged can be confusing.

“Banks offer overdraft services as a benefit to their customers, and the services can provide needed funds in a pinch. But banks never want to see someone dig themselves a hole they can’t climb out of,” says Jimmy Oliver, Senior Vice President, Consumer Omni Channel and Customer Contact Strategy at Regions Bank.

How Do Overdraft Fees Work?

Checks, debit card transactions, and automatic payments can all trigger an overdraft. For certain electronic payments — specifically ATM and one-time debit card transactions (such as a grocery store purchase) — the Consumer Financial Protection Bureau (CFPB) has implemented strict rules around how banks disclose their overdraft services and how banks charge overdraft fees.

If you want to withdraw money from an ATM or pay for something with a debit card, and you have insufficient funds, the bank can only cover the transaction (and charge you a fee) if you opt in for the bank’s overdraft service. Whether to opt in is a personal choice for consumers: Some don’t want the inconvenience of a declined transaction. Others prefer to avoid fees.

Keep in mind that some banks offer an intermediate solution, often known as overdraft protection. If you choose to use this service, the bank can use a linked account, such as a savings account or line of credit, to cover the transaction if you are short of funds in your checking account. This service usually comes with a fee, but it is often much smaller than an overdraft fee.

How Do Banks Process Transactions?

As mentioned, any kind of transaction on your account could create an overdraft. But the order in which these transactions are applied to your account may determine the number of overdraft fees you are charged.

There are a variety of ways in which banks may post transactions to your account. For example, some banks may post transactions based on the amount of the transaction —often phrased as a “high-to-low” posting order. Other banks may post transactions in sequential order, or the order in which the bank receives the transactions. Yet other banks may post transactions using a combination of factors, including when the transaction was received and the type of transaction.

In addition to understanding the order in which your bank posts transactions to your account, you should familiarize yourself with how your bank allocates funds during posting. Many banks place a “hold” on the funds available for processing in order to reserve funds for electronic transactions that have been authorized but have not yet posted to your account. These holds reduce the funds available to cover posting items, which can result in overdraft fees.

No Substitute for Good Money Management

While understanding your bank’s posting order can help, there is no substitute for good money management. Oliver recommends making a household budget and balancing your checkbook on a regular basis. Avoid impulse buying by making a shopping list. For households with shared accounts, give one person control of the debit card and checkbook.

The effort you make upfront to avoid overdrawing your account can save you money in the end.

Learn how Regions posts transactions to customer accounts.

The terms of your financial institution’s account agreement will control how your account works and how related fees are charged.

This information is general in nature and is provided for educational purposes only. Regions makes no representations as to the accuracy, completeness, timeliness, suitability, or validity of any information presented. Information provided and statements made by employees of Regions should not be relied on or interpreted as accounting, financial planning, investment, legal, or tax advice. Regions encourages you to consult a professional for advice applicable to your specific situation.