Overdraft

An overdraft starts with a payment the account cannot cover and a decision the bank makes about it. The bank can pay the item and let the balance go negative, which is the overdraft; decline it at the register, which costs nothing; or send a check or an automatic payment back unpaid, which usually costs a fee at the bank and another at the biller. An overdraft is the bank lending you the shortfall for a fee, and a declined transaction is the bank refusing to, which is why the fee can be far larger than the amount that was short. The negative balance is repaid from the next deposit before any of it is yours.

In a sentence

• "The $95 insurance payment cleared three days before the paycheck, and the overdraft fee cost more than a third of the premium."
• "I turned off overdraft coverage on the debit card, so a purchase the account cannot cover is declined instead of going negative."
• "An overdraft is a payment the bank covered. A bounced payment is one it sent back."

How it works

1. A payment arrives for more than the available balance, which already subtracts pending purchases, so an account whose posted balance looks sufficient can still be short.
2. The bank decides, item by item, whether to pay it or return it. For debit card purchases and ATM withdrawals, banks ask you to opt in before covering a shortfall; without that, the card is declined and nothing is charged. Checks and automatic payments are paid or returned at the bank's discretion.
3. If the bank pays it, the balance goes negative and an overdraft fee is charged per item. Many banks cap the fees charged in a day, waive one for a shortfall of a few dollars, or allow until the next business day to bring the balance back up.
4. If the bank returns it, the payment did not happen. The bank may charge a returned-item fee, the biller may charge its own fee and a late fee, and the bill is still unpaid.

Overdraft protection covers the shortfall from somewhere else, at a price that depends on the arrangement.

An example

The car insurance premium of $95 is due by automatic payment on the 12th, the paycheck lands on the 15th, and $60 is available on the 11th. The example assumes a $35 overdraft fee, standard coverage on automatic payments and no opt-in on the debit card.

The bank covered a $35 shortfall for three days and charged $35 for it, so the premium cost $130 instead of $95, while the declined coffee cost nothing. A linked savings account would have moved $35 across for at most a small transfer fee, and moving the premium's due date to the 16th would have cost nothing at all.

Why it matters

An overdraft is the most expensive way to borrow a small amount for a few days, and the fee does not scale with the shortfall: $35 to cover $35, or $35 to cover $4. It changes whether to opt in to coverage on the debit card, where the usual answer is no; whether to link a savings account instead, which covers a timing gap for far less; and when the automatic payments fall relative to the paychecks, since most overdrafts are timing rather than shortage. The mistake it prevents is spending to the posted balance while pending purchases are still to come out, which is how one afternoon of small purchases produces several fees.

Overdraft versus a declined transaction

An overdraft is a shortfall the bank paid; a declined transaction is one it refused at the moment of the purchase, at no cost to you. The third case is a returned payment, a check or automatic payment the bank refused after it arrived, called a bounced payment or an NSF item, for non-sufficient funds, and it is the worst of the three for a bill: the bank may charge a returned-item fee, the biller adds its own fee and often a late fee, and the bill is still unpaid. For a card purchase the decline is the cheapest outcome, which is why banks ask before covering card purchases and decide for themselves on checks and automatic payments.

Common questions

Should I opt in to overdraft coverage on my debit card? Usually not. Without it, a purchase the account cannot cover is declined and nothing is charged, which is the cheapest outcome for a coffee or a tank of gas. A linked savings account covers a timing gap for less.

How much is an overdraft fee? The bank's fee schedule says. Fees have commonly been around $30 to $35 an item, some banks charge less or nothing, and the fee is the same whatever the shortfall, which is what makes small overdrafts so expensive.

Does an overdraft affect my credit score? Not directly, because a checking account is not a credit account and is not reported to the credit bureaus. A negative balance that is never repaid can be sent to collections, which does appear, and a closed account can be reported to the services banks check before opening a new one.

Go deeper

• How to forecast your cash flow for the next thirty days runs the balance forward date by date to find the low point before it arrives, so a dip is fixed with a transfer rather than a fee.
• Why your budget never matches your bank balance does the subtraction from the balance to the money that is actually free, so tomorrow's rent is never mistaken for money to spend today.
• How to get one month ahead on your bills builds a buffer of one month of bills so the order in which they come due stops mattering.

Where it shows up in Zypper

Zypper shows the money that is about to leave. Pending transactions appear as soon as your bank shares them, marked pending, and count toward the month's spending from the moment they appear. On the budget page, a bill in a spending category counts as money already spoken for in the month it is due, at its usual amount, before the charge arrives, and the Upcoming payment expected notification emails you before an expected payment. See Managing and reviewing transactions and Recurring bills in your budget for the details, or get started with Zypper to see what is due before it leaves.