# Overdraft Explained: Fees, Protection, and Types

## What Is an Overdraft?

An overdraft allows you to continue transactions when your account lacks funds. This bank-provided credit lets you settle payments but may incur fees and interest. Essentially, it's an extension of [credit](https://www.investopedia.com/terms/c/credit.asp) from the financial institution that is granted when an account reaches zero.

The overdraft allows the account holder to continue withdrawing money even when the account has no funds in it or has insufficient funds to cover the amount of the withdrawal.

### Key Takeaways

*   An overdraft occurs when a bank allows customers to continue withdrawing money even if their account balance is zero.
*   Overdraft protection links your checking account to another account or credit line to cover shortfalls but often comes with fees.
*   Excessive reliance on overdraft protection can lead to substantial fees, and abuse may result in the removal of this service by the bank.
*   Banks cannot change the order of transactions to increase overdraft fees, as evidenced by Wells Fargo's penalty for such practices.
*   If unused, an overdraft can be considered a short-term credit option at a lower interest rate than credit cards.

![Overdraft](https://www.investopedia.com/thmb/GDUKOeN1DUUAud8bnekvWNCvLd8=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/overdraft-4191679-899410ea0c854304b930597f7126d1e0.jpg)

*— Investopedia / Madelyn Goodnight*

## How Overdrafts Work: An In-Depth Look 

An overdraft account covers payments that would otherwise be rejected or [bounce](https://www.investopedia.com/terms/b/bouncedcheck.asp) for insufficient funds. Basically, an overdraft means that the bank allows customers to borrow a set amount of money. There is interest on the loan and typically a fee for each overdraft.  At some banks, an overdraft fee can run upwards of $37.

As with any loan, the borrower pays interest on the outstanding balance of an overdraft loan. Often, the [interest on the loan is lower](https://www.investopedia.com/ask/answers/071114/whats-better-way-borrow-money-overdraft-or-credit-cards.asp) than the interest on credit cards, making the overdraft a better short-term option in an [emergency](https://www.investopedia.com/personal-finance/how-to-build-emergency-fund/). In many cases, there are additional fees for using overdraft protection that reduce the amount available to [cover your checks](https://www.investopedia.com/articles/pf/08/overdraft-protection.asp), such as [insufficient funds fees](https://www.investopedia.com/terms/n/nsf.asp) per check or withdrawal.

Banks can charge overdraft fees but cannot reorder transactions to increase these fees. In 2010, Wells Fargo was fined $203 million for arranging withdrawals to maximize overdraft fees.

> **Important**
>
> In 2023, the CFPB found some banks unfairly charged overdraft fees when a positive balance later became negative due to intervening transactions. The CFPB found customers couldn't reasonably avoid these surprise fees. It instructed banks to stop such fees, and many plan to refund affected customers.

## Important Considerations for Managing Overdrafts 

Your bank can opt to use its own funds to cover your overdraft. Another option is to link the overdraft to a credit card. If the bank uses its own funds to cover your overdraft, it typically won't affect your credit score. When a credit card is used for overdraft protection, it's possible that you can increase your debt to the point where it could affect your [credit score](https://www.investopedia.com/how-to-improve-your-credit-score-4590097). However, this won't show up as a problem with overdrafts on your checking accounts.

If overdrafts aren't repaid on time, the bank may send the account to collections. This collection action can affect your credit score and get reported to the three main [credit agencies](https://www.investopedia.com/terms/c/credit-agency.asp): Equifax, Experian, and TransUnion. It depends on how the account is reported to the agencies as to whether it shows up as a problem with an overdraft on a checking account.

> **Warning**
>
> If an overdrawn account isn't paid off in time, the bank may turn the debt over to a collection agency.

## Exploring Overdraft Protection Options 

Some but not all banks will [pay overdrafts automatically](https://www.investopedia.com/terms/a/automatic-transfer-service.asp), as a courtesy to the customer (while charging fees, of course). [Overdraft protection](https://www.investopedia.com/terms/o/overdraft-protection.asp) provides the customer with a further tool to prevent embarrassing shortfalls that reflect poorly on your ability to pay.

Usually, it works by linking your checking account to a savings account, another checking account, or a [line of credit](https://www.investopedia.com/ask/answers/110614/what-difference-between-loan-and-line-credit.asp). If there's a shortfall, this source gets tapped for the funds, ensuring that you won't have a check returned or a transaction/transfer declined. It also avoids triggering a non-sufficient funds (NSF) charge.   
  
The dollar amount of overdraft protection varies by account and by bank. Often, the customer needs to specifically request it. There are a variety of [pros and cons to using](https://www.investopedia.com/ask/answers/071114/what-are-pros-and-cons-overdraft-protection.asp) overdraft protection, but one thing to bear in mind is that banks aren't providing the service out of the goodness of their hearts. They usually charge a fee for it.

As such, customers should be sure to rely on overdraft protection sparingly and only in an emergency. If the overdraft protection is used excessively, the financial institution can remove the protection from the account.

## What Is an Overdraft Fee?

An overdraft is a loan provided by a bank that allows a customer to pay for bills and other expenses when the account reaches zero. For a fee, the bank provides a loan to the client in the event of an unexpected charge or insufficient account balance. Typically, these accounts will charge a one-time funds fee and interest on the outstanding balance.

## How Does Overdraft Protection Work?

Under overdraft protection, if a client’s checking account enters a negative balance, they will be able to access a predetermined loan provided by the bank and be charged a fee. In many cases, overdraft protection is used to prevent a check from bouncing and the embarrassment that this may cause. Additionally, it may prevent a non-sufficient funds fee, but in many cases, each type of fee will be roughly the same amount.

## What Are the Pros and Cons of Overdrafts?

The pros of overdraft involve providing coverage when an account unexpectedly has insufficient funds, and avoiding embarrassment and "returned check" charges from merchants or creditors. But it's important to weigh the costs. Overdraft protection often comes with a significant fee and interest, which, if not paid off in a timely manner, can add an additional burden to the account holder. According to the CFPB, customers who had overdraft protection, in fact, often paid more in fees than those without it.

## The Bottom Line

An overdraft allows you to keep transactions going, even with insufficient funds, by acting as a temporary loan from your bank. While this can provide a short-term solution during emergencies, particularly with overdraft protection, it's essential to weigh the costs carefully. Overdrafts can incur significant fees and interest, which can add financial strain if not managed properly. To minimize these risks, use overdraft protection judiciously and prioritize maintaining a positive account balance.  

> **Article Sources**
>
> 1.  Consumer Financial Protection Bureau. "[Overdraft/NSF Metrics for Top 20 Banks Based on Overdraft/NSF Revenue Reported During 2021](https://files.consumerfinance.gov/f/documents/cfpb_overdraft-table_2024-04.pdf)."
>     
> 2.  Lloyd's Bank. "[Should I Consider a Loan, Credit Card, or Overdraft?](https://www.lloydsbank.com/understanding-credit/loan-or-credit-card-or-overdraft.html)"
>     
> 3.  The New York Times. "[Wells Fargo Loses Ruling on Overdraft Fees](https://www.nytimes.com/2010/08/11/business/11wells.html)."
>     
> 4.  Consumer Financial Protection Bureau. "[Supervisory Highlights Junk Fees Special Edition](https://files.consumerfinance.gov/f/documents/cfpb_supervisory-highlights-junk-fees-special-edition_2023-03.pdf)." Pages 3-4.
>     
> 5.  HelpWithMyBank.gov. "[What Is Overdraft Protection?](https://www.helpwithmybank.gov/help-topics/bank-accounts/nsf-fees-overdraft-protection/overdraft-protection-programs/overdraft-protection.html)"
>     
> 6.  Capital One. "[Does an Overdraft Affect Your Credit Score?](https://www.capitalone.com/learn-grow/money-management/does-overdraft-affect-credit-score/)"
>     
> 7.  Consumer Financial Protection Bureau. "[CFPB Unveils Prototypes of 'Know Before You Owe' Overdraft Disclosure Designed to Make Costs and Risks Easier to Understand](https://www.consumerfinance.gov/about-us/newsroom/cfpb-unveils-prototypes-know-you-owe-overdraft-disclosure-designed-make-costs-and-risks-easier-understand/)."