Overdraft protection might seem like a great idea at first glance. After all, who’d turn down free protection on their bank account? But money expert Clark Howard says this coverage is not all it’s cracked up to be.
If your bank account is nearing a zero balance and you buy something you can’t afford, would you want the bank to decline your transaction? Or would you rather the bank cover you for the shortfall — and then charge you handsomely for it?
That’s the question you need to ask yourself before signing up for overdraft protection.
“If your bank pitches you or has already conned you into signing up for overdraft protection, I want you to ‘un-protect’ yourself,” Clark says. “A study found the typical annual interest rate you pay is the equivalent of 17,000% when your bank ‘protects’ you by paying for something when they know you don’t have money for it.”
Here’s What You Need to Know About Overdraft Protection
In this article, we’ll take a look at exactly how overdraft protection works and how you can opt out of it. Plus, we’ll name a couple of better alternatives.
Table of Contents:
- What Is Overdraft Protection?
- How Does Overdraft Protection Work?
- How Can I Stop Overdraft Protection if I Already Have It?
- What Are the Alternatives to Overdraft Protection?
What Is Overdraft Protection?
Overdraft protection is a service offered by banks and other financial institutions: They pay for a transaction if you don’t have enough money in your account to cover that purchase. But in return for the “favor,” the bank charges a fee against your account.
Overdraft protection can apply to different types of financial transactions:
- Debit card purchases
- ATM withdrawals
- Automated bill payments
But here’s an important thing to note about overdraft protection: This is a program that you have to opt into with either written or electronic consent, according to the Consumer Financial Protection Bureau (CFPB).
If you’ve given your consent to opt into this program, you can get in touch with your financial institution and opt out.
How Does Overdraft Protection Work?
Let’s take a look at a real-world example. Say you’re shopping with your debit card and you don’t have the funds to cover the purchase. Maybe you have only $90 in your account, but the bill is $100.
Your bank will cover the difference for you and approve the purchase if you have opted into their overdraft protection program. While this might seem like a good thing, it comes at a price.
Each overdraft from which your bank “protects” you — by temporarily picking up the tab — costs an average of $33.36, according to an October 2019 Bankrate study. That average is up from $21.57 in 1998.
And if multiple overdraft transactions process on the same day, you can get hit with the fee more than once. That can really put you deep into the red. Of course, it’s still up to you to bring your account into the black in a timely manner even if you have overdraft coverage.
A 2014 CFPB study found that most overdraft fees are incurred on transactions of less than $24. If you were to extrapolate the numbers and put them in lending terms, taking out a $24 “loan” and paying a median $34 overdraft fee would be the equivalent of taking out a loan with a 17,000% annual interest rate!
How Can I Stop Overdraft Protection if I Already Have It?
Thankfully, you can opt out of this coverage even if you already have it. Just follow this process:
Verify You’re Enrolled in Overdraft Protection
The quickest and easiest way to determine if you’re already enrolled in overdraft protection is to log in to your account online and check.
If you find you don’t have this coverage, you’re already all set and don’t need to do anything else. It’s only if you have overdraft protection in place and decide you don’t want it that you need to take the following action:
If You’re Enrolled, Let the Bank Know You Want to Opt Out
When you log in to your bank account online to figure out if you have overdraft protection, you may see something like this:
This screenshot from Wells Fargo’s website shows that the bank makes it easy to remove overdraft protection from your account. Take a look at the green box highlighted at the bottom of the page.
But even if you talk to a bank representative over the phone or visit a branch, the key is to let them know that you want to opt out.
Since July 1, 2010, financial institutions have been required to get your consent to enroll you for overdraft protection on a new account, per CPFB regulations.
What Are the Alternatives to Overdraft Protection?
Fortunately, the bank doesn’t have you over a barrel when it comes to overdraft protection. Not only can you reverse the coverage, but there are also a couple of good alternatives to help you avoid overdrawing your account:
Sign Up for Text Message Alerts
Text message alerts can serve as an effective alternative to overdraft protection on your account. They’re free to set up and, when your account is running low, your bank will let you know.
That way you eliminate the need for overdraft protection completely. It’s a great way to stay out of the danger zone without subjecting yourself to any possible ripoff fees.
“Your bank or credit union lets you know when your balance is getting low,” Clark says. “That should give you the ‘Whoa, be careful spending any money at all signal’ — at least until further deposits are made.”
Another way to make sure you don’t overdraw your account is to get a budget going. Our free budget worksheet is built on the CLARK Method. It offers five steps to better budgeting that are as easy as C-L-A-R-K:
- Calculate your income
- List your expenses
- Analyze your spending and set goals
- Record everything
- Knock out debt and build your savings
When you’re following a well-made budget, you’ll be able to sleep well at night without worrying about where your next dollar is coming from or going to. Most financial experts say you should aim to build up at least a $1,000 rainy day fund.
Overdraft protection is a ripoff that’s pushed as a benefit to bank customers. But really, it’s just symptomatic of a larger trend of the nation’s big banks trying to rip off customers, according to Clark.
“Banks live by ‘fee-ing’ you to death,” Clark says. “So look at online banks, credit unions and small local banks that don’t want to do that. They actually want to serve you.”
To learn how to switch banks, see our step-by-step guide here. It’s easier than you think!