An overdraft happens when withdrawals a consumer’s bank account are greater than the available balance. As a result, the account ends up with a negative balance. The term used for this situation is “overdrawn”. A bank account owner can enter into a prior agreement with their bank or financial institution, for an overdraft protection plan. When this type of plan is in effect, when the negative balance is within the authorized amount, the interest is charged at the agreed upon rate. When the balance is greater then the agreed upon amount, fees are charged and a higher interest rate is a result.

Overdraft protection accounts are also known as “courtesy pay program protection” This type of program pays items presented to a consumer’s account when available funds are not present to cover the amount of the withdrawal. Without this type of protection a bank will more than likely return checks and not pay them on behalf of the account holder. This is particularly true with overdrawing an account happens regularly. When this happens a checking account owner is in the predicament of being charged high bad check fees to the companies they do business with.  It also prevents the receiving institution from knowing that the customer’s account is overdrawn which can serve to protect the customer’s reputation.

Overdraft protection plans may cover ATM withdrawals, purchases made with a debit card, electronic transfers (EFTs), and checks.  However, ATM withdrawals and purchases made with a debit or check card are considered preauthorized and must be paid by the bank when presented, even if the transaction caused an overdraft. If corrected in a timely manner, the cost of overdraft protection is typically lower than the fees charged for bouncing a check. The bank will charge their customer a non-sufficient funds fee (NSF), for bouncing a check and the cashing institution will charge a returned check fee, sometimes in addition to the amount of the check. This system of fines may be dramatically higher than the single overdraft protection fee. This is what makes an overdraft account a good option. Especially for consumers who are not good at keep track of their financial income and outgo.

This type of plan should not be used as a crutch, because if the overdrawn account remains over a long period of time, the costs of overdraft protection are increased. Over time, the interest accumulates and is eventually treated as a line of credit. This line of credit, when not paid, will like be turned over to the credit reporting agencies and show up on the consumer’s credit report, thus lowering credit score. There is a chance that the bank account will be closed if other payment arrangements are not put into place.

It is a good idea to have overdraft protection, but it is best to understand that no matter the safe guards that are put into place, it is best to be diligent in paying what is owed. It is the best, least expensive option available.