What Are Overdraft Fees?

Learn how overdraft coverage works and how to avoid overdraft fees.

While overdraft coverage can serve a helpful purpose in certain situations, it’s not without drawbacks. Learn more about how overdraft fees are incurred, how overdraft coverage works, and tips for avoiding overdraft fees.

What Are Overdraft Fees?

When you make a payment or purchase with insufficient funds, your bank’s overdraft service may cover the transaction rather than decline it. This service is known as overdraft coverage.

In some cases, overdraft coverage can be helpful: Not only can it save you the frustration of having a purchase declined, but it can also help ensure payments on important bills aren’t delayed.

In exchange for covering payment on these transactions, your bank may charge you an overdraft fee. This fee will typically be deducted from your account balance and the amount will vary by institution.

How Do Overdraft Fees Work?

Understanding how your bank’s overdraft services or protections work is key to avoiding overdraft fees. First, it’s important to note that your bank may charge you an overdraft fee for each transaction they cover. In other words, if multiple payments or purchases hit your checking account when its overdrawn, you may incur multiple fees.

It’s also helpful to know how your bank processes (or posts) transactions to your account. Although any kind of purchase or payment could create an overdraft, the order in which these transactions are applied to your account may determine the number of overdraft fees you incur.

There are a variety of ways in which banks might post transactions to your account, and transaction posting order will vary by bank. In general, a bank may post transactions to your account in one of a few ways:

  • By transaction amount, either in high-to-low or low-to-high posting order
  • In sequential order, or the order in which the bank has received the transactions
  • Varied order based on 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 — for example, when a hotel places an authorization hold on your account to cover any incidental charges. These holds can temporarily reduce your available funds, which can potentially cause your account to become overdrawn. The best way to avoid this is by monitoring your available balance throughout the day.

How to Avoid Overdraft Fees

It’s up to you to decide whether you want to participate in your bank’s overdraft service program. If you want to avoid the inconvenience of a declined transaction, you might choose to opt into this service. However, if you wish to avoid the fees that could accumulate, you should consider opting out. Another solution is to open a checking account that does not charge overdraft fees, such as Regions Now Checking.

A more cost-effective option may be to enroll in overdraft protection. If you choose to enroll into this service, your bank will use available funds from another account to cover transactions that exceed your checking account balance. Options will vary by bank, and your bank may allow you to use a savings account, credit card, money market account, or even a line of credit for this purpose. While some banks may charge a fee for overdraft protection, it’s often much smaller than an overdraft fee.

While overdraft protection can be a helpful tool, the most effective ways to avoid overdraft fees is to closely monitor your checking account and keep careful record of pending transactions or choose an account that does not charge overdraft fees. Account alerts and online banking tools such as My GreenInsights can help make it easier for you to keep tabs on your spending.

While mistakes can happen to anyone, a budget may help you stay on-track and avoid overdraft fees. To learn more about how to design a budget that fits your lifestyle, check out our guide to zero-based budgeting.