What’s Overdraft Protection and How Does it Work?

Imagine you’ve dropped by the grocery store to pick up a carton of eggs. It’s a small purchase — just a few dollars for a dozen. At the register, the cashier scans the barcode and the total pops up on the screen. Without giving it a second thought, you swipe your debit card.

There’s just one problem. The eggs cost $2.99, but your checking account balance is down to a dollar.

This scenario can go one of three ways: 

1. You’ve opted into overdraft protection with your bank, so the transaction goes through even though your available balance is too small to cover it.

2. You don’t have overdraft protection, so the bank declines the transaction. You walk out empty-handed, leaving the eggs at the register.

3. You don’t have overdraft protection, so the bank declines the transaction, then adds insult to injury by tacking a nonsufficient funds (NSF) fee onto your account.

The first scenario might seem like the obvious ideal outcome. Overdrafting (or overdrawing) your checking account means you’ll have access to funds you haven’t deposited yet — you’re essentially borrowing money from the bank to cover a purchase.

But don’t go rushing to turn on overdraft protection just yet. There are a few pros and cons you need to consider first.

Think of overdraft protection as a safety net for your checking account — a service many banks and credit unions offer to allow certain transactions to go through even if you don’t have the funds to cover them.

It’s kind of like taking a very short-term loan from your bank, and in most cases, the limit of what you can borrow (or overdraw) each day is pretty small. For everyday debit card purchases, ATM withdrawals, paper checks, and online bill payments, your overdraft limit will typically fall somewhere between $100 and $500, depending on the bank.

We’ve hinted at overdraft protection’s similarities to credit lending, but a few key differences put this service in a category of its own. For one, credit cards and traditional loans require an application and approval, while overdraft protection is usually an opt-in service on your checking account. And although potential lenders can run a report to see the balances and repayment history for your loans and credit cards, overdrafting won’t typically have a direct impact on your credit score (more on that in a minute).

Different financial institutions offer different options for overdraft protection, each with its own set of benefits and drawbacks. Here are three of the most common types.

If your checking and savings accounts are with the same bank, you may be able to link them for overdraft protection. With this option, if you try making an ATM withdrawal or using your debit card and don’t have enough to cover the transaction, your bank will automatically transfer just enough money from the linked account to cover the purchase. Just be sure to check the fine print to see if your bank charges transfer fees.

Think of this as a mini credit card built right into your checking account. It's a pre-approved line of credit that you can tap into if you overdraw. The upside? It might have a higher limit than standard overdraft protection, giving you a bit more wiggle room. The downside? You'll usually pay interest on the borrowed amount, so it's best used sparingly.

This option lets you link your checking account to a credit card. When your bank account gets overdrawn, it’s treated like a cash advance on your credit card. While this can be convenient, remember that cash advances often come with higher interest rates and fees than regular credit card purchases.

We’ve already touched on some of the downsides of overdraft protection, but let’s explore the pros and cons in a bit more detail.

The main benefit of overdraft protection is that you can make card purchases even with insufficient funds in your account. This feature can be especially helpful if you’re in a tight spot, an emergency pops up, or you don’t realize your account will be overdrawn. Not being able to pay for a carton of eggs is one thing, but owing $800 for rent when you only have $600 to your name is another story.

Overdraft protection can prevent the inconvenience and stress of a declined transaction. And at times, it can also save you money. Maybe your property management company charges a $40 fee for every day your rent is late. Or the phone company charges $50 as a penalty for the check you bounced.

Depending on the terms of your overdraft protection, you can go ahead and buy eggs or pay your bills knowing the bank will cover the transaction. And that extra cushion can go a long way toward alleviating your financial stress.

There’s one major downside we haven’t mentioned yet: Many banks charge fees for overdrawing your account. They’re called overdraft fees, and they’re usually around $35 per covered transaction — which means you could wind up paying $37.99 for a $2.99 carton of eggs. 

Sure, that might seem better than paying an NSF fee and walking away empty-handed. But some banks even charge daily or “continuous” overdraft fees, meaning you’ll get charged every day until the balance in your deposit account is positive again. If your account was already down to $1, it’s safe to assume those are fees you can’t afford.

Remember that note we made about an overdraft’s impact on your credit score? While the three national credit bureaus might not find out when you overdraw, it’s a different story if you have unpaid overdraft fees that get sent to collections. And if you have overdraft protection linked to a credit card, the cash advance you get from overdrawing increases your credit utilization ratio, which can also negatively impact your credit score.

Overdrafts can also appear on your report with ChexSystems, the consumer reporting agency that tracks your checking and savings account activity. Many banks and credit unions use ChexSystems reports to decide whether to open new accounts for customers, so a history of overdrafts could make it harder to get a new deposit account in the future.  

Worried about insufficient funds but don’t want to pay for overdraft protection? EarnIn is an Earned Wage Access app that makes waiting for your direct deposit on payday a thing of the past. Our Cash Out tool lets you access your pay as you work — up to $150 a day and up to $750 every pay period — so you have what you need to keep moving forward, whatever life sends your way. 

But having the flexibility to meet your cash needs on demand is just part of what EarnIn offers. With Balance Shield, you can set up alerts to get a heads up when funds are low. You’ll even have the option to auto-transfer $100 from your on-demand pay to keep your balance in the black. And our Credit Monitoring tool allows you to keep a close eye on your credit score any time, for free.

Download EarnIn to make every day payday.