What is an Overdraft?

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Definition:

An overdraft occurs when you try to spend more money than you have available in your bank account, and the bank allows the transaction, sending your account balance below $0 — and usually charging an overdraft fee.

🤔 Understanding an overdraft

When you use a debit card or write a check, you’re directly using the balance of your checking account to pay for transactions. Usually, if you want to pay for something using your debit card, you need to have enough money in your checking account to pay for the purchase. If you try to make a purchase larger than your account balance, the bank may allow the transaction to go through anyway. This action will make your checking account balance go below $0, putting you in debt to the bank. Typically, banks also charge a fee for this service, making overdrafts costly.

Example

Imagine you want to buy lunch while you’re at work, so you visit a local restaurant. You buy a meal, eat, and receive a bill for $15. You go to pay with your debit card but only have $5 in your checking account. Your bank decides to let the payment go through, overdrafting your account and sending your balance to -$10. The bank also charges a $25 overdraft fee, leaving you with a -$35 balance.

Takeaway

An overdraft is like getting a small loan...

When you overdraft your bank account, it means that you spend more money than you have in the account, leaving your bank to cover the rest of your purchase. This puts you into debt with your bank because you have to deposit money to bring your account balance up to $0. Like a typical loan, borrowing money this way usually isn’t free. You generally have to pay an overdraft fee for the service.

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What is an overdraft?

An overdraft occurs when your bank covers a purchase that you try to make despite not having enough money in your account to cover the cost.

For example, you try to spend $20 at the grocery store using your debit card when you only have $10 in your checking account. If the bank decides to let the purchase go through, an overdraft occurs because you’ve spent more money than you have. Your checking account’s balance falls below $0, and you now owe money to the bank.

Banks often allow overdrafts as a courtesy to their customers. Sometimes, you need to spend just a bit more money than you have, so having the ability to overdraft your account can be useful. Typically, banks charge for this service, adding a fee for every time you overdraft your account. Some argue that the fees incentivize banks to offer overdraft services, as a revenue source.

Depending on the bank you use and the type of account you have, you may have multiple options for overdraft protection. For example, some banks offer to automatically transfer money from a linked savings account to cover overdrafts.

How does an overdraft work?

When you try to pay for something out of your checking account by using your debit card or a check, your bank clears the transaction. It is then up to the bank to transfer funds from your checking account to the recipient.

In most cases, this is no issue. Your bank transfers the required amount from your account and sends it to the receiving bank. However, if your account’s balance is too low to complete the full transaction, your bank has to make a decision. It can decline the transaction, or it can allow it to go through anyway. If the bank agrees to let the purchase go through, it overdrafts your account, sending your balance below $0.

Most of the time, your checking account’s balance is above $0. When this is the case, in some ways, it means the bank owes you money. You can go to the bank anytime and ask for your money back. If your account balance is below $0, it means that you owe a debt to the bank. You have to deposit money to bring your balance back to $0, so you can start using the account normally again.

Banks typically charge a fee when you overdraft your account. In 2019, the average fee was about $33. Banks usually deduct this fee from your checking account balance when the overdraft occurs, pushing your account balance further into the negative.

Do banks charge overdraft fees on weekends?

Yes, banks charge overdraft fees on the weekend. You will pay an overdraft fee whenever your bank approves a transaction that sends your account balance below $0, even if the purchase happens on the weekend.

Some banks also charge daily overdraft fees if you let your balance remain negative for some time. If your account balance is negative on a weekend day where you cannot make deposits because the bank is closed, whether the bank charges a fee can vary. The best thing to do is look at the fee disclosure that your bank provided when you opened your account.

How much does it cost when you get charged overdraft fees?

Each bank is free to set its overdraft fee, and many banks offer different types of overdraft coverage. For example, you may be able to choose from letting your account balance go below $0 or automatically transferring funds from a linked savings account to cover the potential overdraft.

In 2019, the average overdraft fee was about $33.

Some banks place limits on the number of overdraft fees they’ll charge each day, and some banks won’t charge for very small overdrafts, for example, overdrafts that leave your balance higher than -$5.

The best way to know how much an overdraft will cost is to check your bank’s fee schedule.

Can overdraft fees be waived?

Yes, you can get overdraft fees waived, but it isn’t a sure thing. It helps if overdrafts aren’t a frequent occurrence for you.

If you overdraft your account and get charged a fee, the best way to get the fee waived is to call the bank. Ask the customer service representative if they can waive the charge as a courtesy. They might be able to help you out. Feel free to mention that you’ve been a long-time customer if that’s the case.

Be polite, and don’t be afraid to ask for the refund that you want. If the person says no, you can always try calling back again later. Often, you’ll be able to get the fee refunded, especially if it’s the first time you’ve asked for a refund.

If the bank can’t waive the fee, you’ll have to pay it, making avoiding overdrafts the best way to avoid the charge.

Do overdraft fees affect your credit score?

Overdraft fees don’t directly affect your credit score. While lenders report your credit history to credit bureaus, banks instead report your interaction with your bank accounts to a system called ChexSystems. The credit bureaus don’t collect information on overdrafts.

The one way that overdrafts can impact your credit is if the lender sends your account to collections because it’s had a negative balance for too long. That means that depositing enough funds to bring your balance back to $0 is essential.

How can I avoid overdraft fees?

The best way to avoid overdraft fees is to keep sufficient cash in your checking account to prevent yourself from spending more than you have in the account.

Some banks offer alternative overdraft plans, such as automatically moving money from a linked savings account to cover overdrafts. These services typically have a lower fee than an overdraft, which makes them a good option for many people.

You can also opt-out of overdraft coverage entirely. If you do this, the bank automatically declines any transactions that would cause you to overdraft your account. You’ll lose the flexibility to spend a bit more than you have in the account, but you won’t have to worry about overdraft fees.

Some other ways to avoid fees are: 1. Set up account alerts for low balances 2. Deposit money quickly after an overdraft to avoid multiple fees 3. Use a prepaid debit card instead of your bank debit card 4. Use an app that makes it easy to track your account balances

What is overdraft protection?

Overdraft protection is a service that some banks offer that help you avoid overdrafting your account. This service funds purchases that would overdraft your checking account in some other way.

A common form of overdraft protection is transferring money from a linked savings account to your checking account automatically when you would overdraft the account. This lets you avoid the overdraft fee and keeps your account’s balance from going negative. Banks do customarily charge a service fee for this but you avoid higher charges and the negative implications.

Some banks also let you link a line of credit or credit card to your checking account to prevent overdrafts. This is usually more expensive than connecting a savings account because you’ll have to pay interest on the money you borrow and pay cash advance fees.

One pro of overdraft protection is that it can help you avoid overdraft fees, but it has downsides. Knowing that you have protection in the event of an overdraft might make you more likely to overspend instead of limiting your spending to your account balance.

The drawback of some overdraft protection plans, particularly those that link with a credit card or line of credit, is that they can cause you to fall into debt and force you to make large interest payments.

The best thing to do if you want to avoid overdraft fees is to opt-out of overdraft services entirely. You’ll never pay a fee because the bank will decline any transaction that would overdraft your account.

Ready to start investing?
Sign up for Robinhood and get your first stock on us.Certain limitations apply

The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

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