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What is overdraft protection and how does it affect your credit?

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Overdraft protection allows transactions, payments and checks with debit card and ATM to be made even if your bank account does not have sufficient funds. Most banks and credit unions offer overdraft protection for their checking and savings accounts.

While having overdraft protection may seem like a good idea, there are often high associated fees. Each time you make an overdraft, even for a few dollars, a considerable fee and potential interest can be charged to your account.

How does overdraft protection work?

Overdraft protection works by having an agreement with your financial institution to allow funds to be withdrawn for a fee, even if you don't have enough.

When a charge occurs beyond your balance, overdraft protection is activated and allows the transaction to take place. The funds are transferred to anyone who requests it, such as an ATM or a utility company. Your financial institution provides the funds as there is not enough in your account.

example of overdraft protection

Each time you request funds beyond the balance, you are charged an overdraft transfer fee. In general, if you make many purchases, you will be charged for each transaction. You may also be charged interest on the amount until you pay it to the bank.

What rates and limits should I expect?

Some financial institutions also charge a monthly fee for providing overdraft coverage. The cost of overdraft protection depends on your bank, but is usually around $ 35 per transaction. There may be other charges incurred for each day that the account has a negative balance.

Most banks do not charge for overdrafts of less than $ 5. For example, if you have $ 2 in your account and buy a $ 4 latte, you will not be charged for an overdrawn account. Persecution It is an example of an institution that does not charge for overdrafts of less than $ 5.

Banks and credit unions often have a limit for overdraft protection, such as $ 750 to $ 10,000. Once you go beyond your balance, you cannot use more funds. Check with your bank for rates and limits when it comes to overdrafts on your account.

Usually, those without overdraft protection pay much less in fees.

Example of how overdraft protection works

Jeremy goes out to lunch with friends in a restaurant that only pays in cash. He takes out $ 20 from the ATM, but his account only has $ 11. The ATM gives him the $ 20 because he has overdraft protection. The bank charges a fee of $ 32.

Your $ 15 lunch now costs you $ 47 ($ 15 + $ 32 overdraft). If you make more purchases before recovering your balance, another overdraft fee will apply.

Is overdraft protection a good idea?

Whether overdraft protection is a good idea or not depends on your financial situation and the fees charged by your bank. Before using an overdraft service, make sure you understand the charges and interests that may apply. Compare those costs with the costs of not having overdraft protection. Consult with a similar financial or professional advisor for guidance on your situation.

Here are some pros and cons to consider with overdraft protection:

Pros

Having overdraft protection can help you in certain situations, such as when you are in trouble for cash.

  • Allow transactions to pass, checks to settle and withdrawals at ATMs to process when you don't have enough money.
  • Allows you to have funds or cash when you need it in case of emergency.
  • It gives you access to cash between paychecks.
  • Limit the high rates related to insufficient funds, checks without funds or closing your bank account (in extreme cases).

Cons

Overdrafts can be expensive and lead to poor money management. Check the fine print to make sure you understand the terms of your bank's overdraft protection. The terms vary with all financial institutions and credit unions.

  • It is expensive with high overdraft protection fees and interest (add up)
  • Transactions may not be deleted if you don't have enough cash
  • Encourage spending money you don't have available
  • Create a false sense of financial security

What are the alternatives?

In addition to overdraft protection, there are other ways to avoid spending more than you have. By lawOverdraft protection is an optional service and is not something you have to do when opening a checking or savings account.

Instead of overdraft protection, keep your finances safe by:

  • Sign up to receive alerts by email or text message when your account has few funds.
  • Using a transfer service You transfer money automatically from another linked account (for example, from your savings to your checking account) when your account balance is low.
  • Monitor your bank account online for expenses, unusual activities and a low balance.
  • Download a mobile banking application so it’s easy to check your available balance.
  • Using your credit card for purchases You can pay by the end of the month.
alternatives to overdraft protection

Does overdraft protection damage credit?

Overdraft protection itself does not harm your credit, but it can affect your credit if you link your credit card to your checking account or if the overdrawn amount is going to be collected.

When a line of credit is used to cover the overdraft, you can generate an exhaustive query on your credit report. Check with your bank to see how they handle reports to credit agencies. If you the overdraft amount is sent to the collections, it could appear as a negative mark on your credit report.

If you link your bank account to your overdraft credit card, some credit card issuers will treat the overdraft payments as cash advances. These transactions are more expensive and risky (for example, higher interest rates, no grace period, cash advance fees). If you do not have enough funds available on your credit card or line of credit, the transaction can be rejected anyway. You may be charged an overdraft fee independently.

When you use the loan to cover insufficient bank funds, the situation may get worse if you cannot pay the overdraft costs. It impacts you in two ways:

  • First, when you don't make payments because you can't cover the amount, your credit score gets hit. Lost payments are the main factor in determining your credit score.
  • Second, it will have a higher credit utilization rate.—The second most important aspect of your credit score. The greatest use of credit occurs when you use a higher percentage of your total available credit.

How else can I improve my finances?

Decide if overdraft protection is right for you by observing your financial situation and the terms of your bank. In most cases, overdraft services are expensive.

Regardless of what you decide, it is vital to practice good financial habits. Paying your credit cards on time and not spending too much or using them too much can improve your finances and improve your credit score. Improve your financial well-being by fixing your credit and increasing your credit score.

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