Overspending Your Checking Account: Overdraft vs. NSF Fees

One of the basic rules of using a checking account is that you should never spend more money than you have available in your account. Break this rule and you'll receive a financial penalty, either an overdraft fee or a nonsufficient funds fee, depending on what the bank does with the offending transaction.

How Overdraft and NSF Fees Work

When a bank receives a transaction against your account, for example a check you wrote to cover your monthly rent or a debit card transaction for a hotel stay, the bank checks your account balance to confirm you have enough to funds to cover the amount. When you have enough money to cover the transaction, the bank pays the transaction and deducts the amount from your account balance.

On the other hand, if you don’t have enough money to cover the transaction, the bank may still pay the transaction but using their own funds, or they can reject the transaction. When the bank pays the transaction despite your lack of funds, they charge you an overdraft fee plus the amount of the transaction. As a result, you’ll have a negative balance until you make a deposit that at least covers the deficit. Future transactions may also overdraft and they’ll also incur an overdraft fee.

Alternatively, the bank can reject transactions that exceed your available checking account balance. Unfortunately, when they do this, they also charge a nonsufficient funds fee. Yes, even though the transaction wasn't paid, you still have to pay a fee.

What’s slightly worse about returned transactions is that banks allow the merchant (the business or person presenting the payment) to re-submit the transaction a second or even third time. Each time the payment is returned for nonsufficient funds, you’ll incur an additional NSF fee. The merchant may even charge a returned check fee on top of the amount of the original transaction.

Opting-Out of Overdraft Fees

Federal law allows consumers to opt-out of overdraft charges for debit card transactions, but not nonsufficient fees. If you choose to opt-out, debit card transactions that exceed your checking account balance would be declined. Some people choose not to opt-out because it means important payments may not be processed. Or, they’d rather save themselves the embarrassment of having their debit card declined. These consumers instead, opt to pay the overdraft charge.

A new study from the Consumer Financial Protection Bureau reports that being overdrawn costs consumers an average of $225 each year. In addition, one in five checking account customers overdraws their account.

Opting-out has proved to be beneficial for some. According to CNN Money, chronic overdrafters who opt-out saved an average of $450 in fees in the months after the Federal law became active in 2010.

If you’re frequently paying overdraft fees, opting-out may save you hundreds of dollars in overdraft fees each year since the transactions that would cost a fee would be declined. Knowing that your transactions won’t be processed anyway may help curve your spending habits.

No Opting-Out for NSF Fees

Unfortunately, the law won’t save you from nonsufficient funds fees. If you bounce a check or have another transaction rejected because you don’t have enough funds in your account, you’ll still incur that fee. The only way to avoid the nonsufficient funds fee is to keep enough money in your account to cover the transactions you make. Create a habit of checking your account balance if you’re unsure about whether you can afford a transaction.

Many banks offer an overdraft protection service that links your checking account to your savings account. The savings account would act as a backup source of funding if your checking account balance is overdrawn. There’s typically a fee for this service, but it’s smaller than an overdraft fee. You may also be able to transfer money from your savings account to your checking account proactively, without being charged a fee.

Source: CNNMoney.com