An overdraft occurs when you spend more money than you have available in your checking account, resulting in a negative balance. Most financial institutions offer overdraft protection, but relying on this service without fully understanding how it works can create a cycle of overdraft and NSF (non-sufficient funds) fees that’s hard to break out of.
Account balance ignorance
It’s easy to overdraw your checking account if you’re unaware of your account balance. Be mindful by reading your monthly statements, by checking your account balance regularly, and by tracking your expenses with a checkbook register or with a budgeting app.
When you make certain purchases like paying for gas at the pump, a hold can be placed on your debit card. This means that a larger portion of your available debit balance is “frozen” until the transaction goes through. If you’re already close to overdrawing your account, a hold can trigger a negative account balance without your realizing it.
Even if you’re hyper-vigilant about your account balances and expenses, the time and order in which transactions are processed can sometimes wreak havoc on your account balance. Be aware of your financial institution’s holding periods so that you don’t end up spending money you don’t have.
Overdraft protection vs. opting out
Let’s say that you’re buying a brand-new gadget at the store. Your last paycheck hasn’t cleared, so you’re unaware that your current available balance is only $150. The gadget costs $160. You pull out your debit card and…
With overdraft protection
- The transaction goes through
- Depending on how your financial institution handles overdraft situations funds are transferred from your savings account to cover the transaction
- OR your account then becomes overdrawn, resulting in a negative balance
- You avoid the inconvenient situation of having your card declined
- You may be charged an overdraft fee
- You may be charged an NSF (non-sufficient funds) fee for having a negative balance
- You may also be charged a recurring fee until your balance is positive
- If you frequently overdraw your account, you may be able to pay a monthly fee to reduce your total fee costs
Without overdraft protection
- Your card gets declined and the transaction does not go through
- You avoid a negative balance and any potential NSF (non-sufficient funds) fees that go along with it
- Having your card declined can be inconvenient and embarrassing
- In emergency situations, it can be extremely troubling
Did you know?
According to Regulation E, consumers have the ability to opt out of overdraft protection for any debit card or ATM transaction.
How to stay ahead of the fees
Set up alerts
Most financial institutions will allow you to set up alerts that will inform you of your balance. You can receive a daily text message or email with your balance. In addition, you can usually set up an alert for a specific account balance. For example, you may want to receive a text message when your account balance reaches $200, so that you receive sufficient notice to add more funds or curtail your spending.
Find a better way to borrow
Sometimes, you just need to borrow money until the next paycheck arrives. Although the best advice is to build an emergency fund so that you are not dependent upon borrowing, this isn’t always possible. In order to protect yourself from the high costs of short-term borrowing, consider taking out a credit card with a low interest rate for emergencies. Credit unions usually charge the lowest interest rates on credit cards. These products will not offer rewards, but they tend to offer lower interest rates that can be useful if you need a short-term loan. Keep in mind that having a credit card does not give you a license to spend money you do not have—it should be used in an emergency situation for items that you need, not items that you want and cannot afford.
Balance your checkbook
Balancing your checkbook gives you power—the power of knowing exactly how much money is available to you. Whether you use a checkbook register, a spreadsheet on your computer or an app on your mobile device, balancing your checkbook is a good habit to form.
Sources: CreditCards.com, Forbes
Are Checks Obsolete?
Checks hold an odd place in our personal finances. In many ways, checks seem like relics from a previous era. We maybe write one or two checks a month (usually for rent or similar bill-paying situations where electronic payment simply isn’t an option). This is vastly different from only a few decades ago, when checks represented more than 85% of all non-cash retail payments. (Can you imagine whipping out a checkbook in line at the grocery store? Times have certainly changed!)
However, despite their gradual decline in use, checks haven’t become completely extinct. We still keep our money in checking accounts, we still balance our checkbooks, and new banking technologies (mobile check imaging is one example) are being introduced to improve the process of paying by check. Writing checks continues to walk the line between permanence and obsolescence.
Whether or not checks are on their way out, there are still a couple of check-related best practices that you need to be aware of in order to stay on top of your finances.
Holding periods exist, and you need to keep track of them
Checks often get a bad rap for the amount of time they take to clear. This is referred to as a holding period, and it can vary anywhere from a day to over a week, depending on your financial institution.
The clearing process itself is made up of several steps. First, the financial institution that receives the check for deposit encodes its dollar amount into the machine-readable numbers along the bottom of the check. Then the physical check is fed through a machine that scans its data. That data is then sent to a clearinghouse, which forwards the information to the financial institution that issued the check. The financial institution makes sure the check-writer’s account has sufficient funds to make the payment—if it does, the transaction goes through, but if the account has insufficient funds to complete the transaction, the check bounces.
Check clearing might sound like a long and overly complicated process, but it has come a long way. In 18th century England, the check clearing process was considerably less efficient. It involved clerks from each London bank meeting up at a tavern on Lombard Street to exchange checks and settle account differences—not the most scalable process!
The introduction of mobile check imaging (also known as remote deposit capture) and other technologies is helping to shorten the holding period; however, to avoid fees, bad checks and other sticky situations, it’s still important for you to understand what the holding period is at your credit union or bank.
If you’re the check writer: it’s best to pretend that the related amount of money is gone from your account the moment you write your check. With today’s technology and electronic clearing processes, funds can be immediately held from your account when your check is scanned.
If you’re the check receiver: keep in mind that when you deposit a check and the money shows up in your account, the check may not have cleared yet. Your financial institution may allow you to spend a portion or all of that deposited check, but if it bounces, you would be the one responsible for repaying any funds you used before the check bounced. It’s a good practice to confirm that a check has cleared before spending it. When in doubt, you can always give your financial institution a call to verify the status of a check.
Balancing a checkbook is still an important skill
The best way to avoid tricky scenarios created by holding periods is to keep track of your transactions with a checkbook register. Traditionally, checkbook registers are those lined notebooks that come with your checks, but you can use any system that works for you, whether that’s a printable form, a digital spreadsheet or even an app on your phone.
Recording your transactions as you go will give you a more accurate idea of your account balance and help you avoid unnecessary fees or overdraft charges. It also takes the guesswork out of writing a check or making an ATM withdrawal—you will know whether or not you have the money in your account to cover it. Comparing your checkbook register to your monthly statements also makes it easier for you to spot any errors or fraudulent charges.
Start by recording all your checking account transactions in your checkbook register—debit card payments, checks written and received, and ATM withdrawals. Include online bill payments and direct deposits too—since those are sometimes automated, it can be easy to forget them. When you get your monthly statement, compare each transaction to your checkbook register and put a checkmark next to each transaction that matches your statement. If items in your statement do not match your checkbook register, figure out what’s at cause. Sometimes it’s an entry error or a slip-up in your math, but it could be an error by your financial institution.
Since we are not yet a totally digital society, understanding how to use paper checks as well as keeping track of all of your transactions will keep your checking account in the black and your financial matters running smoothly.