Ask the Piggy Bank: Is Overdraft Protection Worth It?
September 2, 2008 by Miranda Marquit
Filed under Finance
I love me some questions from readers, and I thought this one, in light of my recent adventures in banking, was a great one:
Is overdraft protection worth it?
One of the things I love about personal finances is that they’re, well, so personal. Really, it depends on your habits. First, though, a little background on overdraft protection.
What is overdraft protection?
Overdraft protection is a loan. It is a line of credit that you are allowed (usually between $1,000 and $10,000, depending on what you are approved for) to use when your account goes into the red. The idea is to help you avoid the hefty fees that come, per transaction, when you overrun your account.
There are, however, fees associated with overdraft protection as well:
- Interest charges (usually in the neighborhood of 13% to 18% APR).
- Annual fee (around $25).
- “Advance” fee (somewhere between $5 and $7 per transaction, if you don’t move the money from your credit line yourself and the bank has to do it for you after you go negative).
Is overdraft protection worth it?
Now we answer the question. If you occasionally go into the red due to cash flow realities, carelessness or for some other reason, overdraft protection can be worth it — especially if you know the money will be replaced almost immediately. Fees on overdrawing your account can range from $34 to $45 per transaction (my bank charges $38), putting you ever deeper in the hole. Each $4 coffee that you buy results in a hefty fee once you go negative.
Even at the relatively high interest rate, overdraft protection can be worth it, since, as a revolving line of credit, the interest is only charged while you are negative. Just one transaction that puts you negative could make overdraft protection worth it. If you feel that it will ease your cash flow, it is worth considering. But remember: Overdraft protection is a loan.
If, however, you are very scrupulous about your account, and if you stay out of the red all the time, with adequate padding, there is no reason to get overdraft protection. It’s just so much extra cost.
image credit: sxc.hu
Overdraft protection can be worth it…but not if it’s tied to a line of credit. I don’t know if all banks are like this, but mine allows you to tie it to another account that you hold there, such as your savings account. Then you only get hit with the transaction fee. No annual. No interest.
My bank doesn’t promote this but I know it’s offered because I used to work there. You may just have to ask your bank about it specifically.
One more point…at my bank, they only do transfers from the line of credit in $50 increments. Overdraw your account a dime…it costs you $50 plus the transaction fee.
Thanks for sharing, James! I like this idea of connecting your checking account to your savings account. I checked with my bank, and no dice. Maybe I need to shop around for a better bank.
This was something I wish I had recently. I made a silly mistake when I transferred $1500 out of my main checking, leaving myself about $100 in my checking account after all the bills were paid (i thought). I only realized later that I had forgotten about the $145 homeowner’s association bill coming out of that same account.
Even though I actually had several thousand dollars in my saving account, they charged me almost $200 in overdraft fees before I realized something was wrong. They reversed 1/2 the charges, and I paid them – but I wished I had gotten the overdraft protection.. I could’ve saved $75.
The reason I hadn’t signed up originally was because my previous bank gave overdraft protection for free – while this new one charged $25/year. Time to switch back to the other bank?
Thanks, Peter, for sharing! One of the maddening things about banking is that otherwise savvy and responsible people occasionally make mistakes. Things are forgotten. We transfer things from the wrong account. And when it does happen, it can cost hundreds and hundreds of dollars in fees.
I don’t think overdraft protection would really be worth it for me (I’ve only overdrawn a couple of times in the past four or five years, and neither time was an amount so high that I didn’t have it paid right back relatively quickly), but I can see how it would benefit others (namely, people who deal with much larger amounts of money in their checking accounts than I do, haha).
Thanks for sharing! It really does depend on what works best for you.
Well thought out post, Miranda. Thanks.
My bank makes me have overdraft protection. My husband and I used the same account and he would use the debit card without checking the amount of money in the account. As a result we would end up with over $1000 per year in overdraft charges. I ended up taking his card away from him and canceling any automatic payments and now we have no overdrafts.
Thanks for sharing. That’s a lot of fees! My husband and I had that issue as well, for a while. I told him that if he wanted to use the debit card, he needed to check the account and then record what he spent, or at least bring me the receipts every day so that I could make a record.