Bank Overdraft Protection: Convenience, or an Inconvenient Fee?

If you have used a check or debit card associated with a checking account at a bank, you are probably familiar with your bank's overdraft protection policy. You might have even received one of those thin letters in the mail that pop up every time you make a withdrawal over your limit, or see a "non-sufficient funds (NSF)" fee in your transaction list online. For those fortunate enough to not have extensive personal experience with overdraft fees, they are simply the fees the bank charges to cover transactions you make above the amount you have in your account. For example, if you swipe your card at a fast food restaurant, charging fifteen dollars, and you only have seven in the bank, the transaction will still go through; the bank will cover the eight dollars you are short causing your account to be in the red. The price you pay for the "convenience" of this coverage can range from around $20 to $40, depending on your bank's policy.

Prior to this year, most bank accounts came with overdraft protection as a standard feature. To avoid paying fees, a customer would have to open a savings account or CD, and in the case of an over-withdrawal, the insufficient funds would be deducted from the other account. Now, due to new federal regulations, if you opened an account prior to May 1, 2010, overdraft protection will no longer come standard unless you opt-in to the coverage by August 13, 2010. If you opened an account after May 1, you had the option to opt in or out at that time; however, you are free to change your coverage at any time.

There are several pros and cons to continuing to use your bank's standard overdraft protection. I personally was extremely happy when I discovered I had the option to opt out. One of the major drawbacks of this feature is that once your account goes negative, such as in the example of the fast food transaction above, every withdrawal after that is subject to the overdraft fee. My bank charges $35, so if I accidentally overdraw my account at Taco Bell, I just bought a $50 combo meal. Then, without realizing it, I put $75 worth of gas in my Ford Focus, tip the pizza deliver man $43, and so on. If you aren't careful (especially if you have checks pending or automatic debits for bills), you can rack up hundreds of dollars worth of these fees -- and the banks are pretty inflexible about courtesy refunds.

Banks make a huge bucks from these fees, and they arrange the order the transactions come out of your account in order to maximize profit. Say that you have $50 in the bank. You buy a coffee for $5, get a movie ticket for $10, order lunch for $15, buy a soda for $2, then splurge on a pair of shoes for $40 (In this order). If you do the math, it would look like you would still have $8 in the bank when you walk into the shoe store. Even though you overdraw your account, it's only one $35 fee, right?

Not necessarily. The bank pays the merchant, but doesn't have to take the funds from your account the minute your card hits the register. In many cases, the bank will process the shoe purchase first, leaving you with a paltry ten dollars. Next it will deduct your $15 lunch, leaving you five in the hole and one NSF fee. Next comes the coffee, the movie ticket, and the soda -- three more NSF fees. If each fee is $35, your day (purchases + fees) has cost you two hundred andtwelve dollars. This may sound extreme, but it can happen before you even realize it.

On the plus side, there are a few positive aspects to standard overdraft protection. Sometimes you need access to funds you don't have in an emergency, such as if someone gets ill or your car breaks down. In situations where someone's health or job is on the line, a $35 fee is a small price to pay. Even in non-emergency cases, it can be comforting to know that you have the ability to make a certain purchase or pay bills. It is far better, for example, to incur a small fee from the bank and pay your credit card on time; late credit card payments are going to cost you far more in interest hikes than a one-time fee.

My bank touts their standard overdraft protection as a service that save you the "embarrassment" of having your card declined. In the example above involving the multiple transactions, I would much rather have the clerk at the shoe store decline my card in front of a line of onlookers, than pay $140 to spare myself the humiliation.