In an ideal world, you’d always have the money in your bank account that you need to buy whatever you want. But sometimes for whatever reason, your checking account might not have the money you need to pay for things– whether that’s goods, services, bills, or any other financial burdens you may have. If this happens, you may find that you have accidentally overdrawn your checking account.
Like damage to your credit card’s FICO score, overdrafts affect credit scores negatively, and that’s not ideal for you. Maintaining a good credit score is important for your future financial planning and ability to make major purchases and get large loans, like mortgages, comfortably. It can be a tricky balance to find just the right amount of credit to use– too much and you risk not being able to pay it off, but too little and you won’t develop a good credit score. While there are many factors that go into a healthy credit score, avoiding overdraft is the focus of today’s article.
What Is Overdraft?
Overdrafting occurs when you try to spend more money than you have in your checking or savings account. This can happen if you write a check, make a debit card purchase, or set up an automatic payment that tries to withdraw more than you have in your account. When this happens, one of two things happens.
- The bank will approve the transaction anyways and charge you an overdraft fee.
- The bank will decline the transaction and return it as insufficient funds.
Regardless of whether you use a bank or a credit union, an overdraft can happen.
Are Bounced Checks and Overdraft The Same Thing?
When you overdraft from a checking account, payments typically do not go through. However, sometimes there are circumstances where the payment does go through and the check “bounces.” While bounced checks are a type of overdraft, they can actually incur greater financial penalties than overdraft fees.
When a check bounces, the bank will typically charge the account holder a fee for the returned
check and will also notify the recipient of the check that the payment has been returned. The recipient of the bounced check may also charge the account holder a fee for the returned check. Banks and credit unions don’t pay bounced checks, so in addition to the money you owe the bank for the overdraft, you also owe the business you attempted to buy from. This is similar to the scenario where the bank declines your transaction and returns it as sufficient funds.
If your check bounces, you need to take steps to resolve the problem right away.
- First, you need to contact the recipient of the check to arrange for payment.
- Then, you need to deposit funds into your account to cover the amount of the check, the fee from your bank, and the fee from the business
- If the bounced check was written to pay a bill, you should also contact that business to let them know what has happened and make arrangements to pay the bill.
Like other types of overdraft, writing a bounced check can also damage your credit score, as banks and credit unions report bounced checks to the credit bureaus. To avoid bouncing checks, it’s important to keep track of your account balances and to deposit funds into your account as soon as possible when you write checks.
How Does Overdraft Affect Credit Score?
The good news is that overdraft does not immediately affect your credit score. Banks don’t typically report the money in a checking account to credit bureaus because it’s not money you’ve borrowed. Additionally, you may qualify for overdraft protection. If you do, then the bank will pay what you owe. You will just have to make up the negative balance and pay an overdraft fee, none of which is ever reported to a credit bureau.
However, if you overdraw frequently, it can hurt your credit score. The bank may sell your debt to a collection agency as a charge-off. In this case, negative balances affect your credit score because the agency may report what you owe as outstanding debt to the three major credit bureaus. This will ding your credit score!
Overdraft Protection
Many banks and credit unions offer debit card overdraft protection services that can help you avoid overdraft fees. This can include linking a savings account to your checking account so that if you don’t have enough funds in your checking account, the bank will automatically transfer money from your savings account to cover the shortfall.
However, when this happens, you typically incur an overdraft fee. This is a fee the bank charges to take money from that line of credit or savings account. For banks, this is a lucrative operation. According to a 2020 study from the Oliver Wyman research firm, overdraft and insufficient funds fees generate $17 billion annually for banks. The study also found that:
- Frequent overdrafts average around 11 fees per overdraft cycle
- Frequent overdrafters with 20 or more penalties a year have lower credit scores and lower bank balances
- 5% of bank customers pay 63% of all overdraft fees
- 80% of overdraft fees are paid by people living paycheck to paycheck or with consistently low balances
As a result, many banks have begun to see that overdraft fees are perceived as predatory, and have moved towards a no-fee model. Online-only financial institutions are beginning to offer accounts with no-fee overdraft protection, like Ally Bank, Discover Financial, and Chime.
If your bank or credit union still charges overdraft fees, and you accidentally incur one, you may be able to get the fee waived– especially if it’s your first time overdrafting or you’re an infrequent overdraft. While most overdraft fees are between $25-$25, which doesn’t seem like much, these fees can quickly add up. Overdraft fees are charged per transaction, so if you don’t realize that you’re overdrafting, you may make numerous transactions, or have several separate transactions try to go through at once. This can quickly turn a $25 fee into a financial nightmare. If this happens, you need to call your bank and ask what they can do to help.
How To Ask For Overdraft Fee Waiving
To get overdraft fees waived, call your bank’s customer service line and politely ask for the fee to be waived. Make sure that you let them know that this is a rare occurrence; if you’ve been banking with them for a while, be sure to bring up how long you’ve been a loyal customer. If the first customer service representative says no, try again later– sometimes it depends on the representative. The most important thing is that you stay polite and courteous. Keep a cool head and don’t get angry or demanding.
However, the best way to make sure that overdraft does not affect your credit score and to make sure that you don’t have to pay overdraft fees is to avoid overdraft in the first place.
How To Avoid Overdraft
Nobody wants to deal with overdraft fees. They can add up quickly and place a huge burden on your finances, as well as your emotional and mental health. The stress of overdraft fees can cause you to spiral and lose control of your finances as the fees continue to add up. Fortunately, there are ways to be proactive and manage your account balances carefully to avoid overdraft fees.
Track Your Account Balance
The most effective way to avoid overdraft fees is to just stay on top of your account balances. Today’s banks all have online banking apps that help you stay on top of your balances. You can set up account alerts to notify you whenever your balance is low; most banks have tools that allow you to get notifications whenever your account balance drops below a certain amount or whenever you have a withdrawal or expenditure over a certain amount. Setting up these notifications will let you know immediately what your account balance is and help you with your financial decisions.
Use A Budgeting App
Budgeting apps are a great way to avoid overdraft. They allow you to track your spending in real time, so you can see exactly where your money is going. This can help you identify areas where you can cut back on expenses and improve your financial situation. A budgeting app can help you set spending limits, ensure financial awareness, and increase financial accountability and help you stay on track to meet your financial goals. Unlike a spreadsheet or physical account book, budgeting apps are convenient and can be linked directly to your bank account. You can quickly and easily input your transactions (if they don’t automatically upload), categorize expenses, and track your spending over time. All of this makes you more financially literate and helps you avoid the inconvenience of overdrafting!
Don’t Use Checks
With every passing year, paper checks edge closer and closer to going the way of the dodo. In almost every situation, you not only don’t need them for your personal transactions– many businesses refuse to take them. They’re inconvenient for everybody involved, so stop using them. Use your debit card instead– the transaction is automatically deducted from your checking account balance and makes it much harder to spend over what you have in your account.
At Save Plan Retire, we want to help you achieve your financial goals by promoting lifetime financial literacy. Check out our blog to learn more about protecting your credit score and developing your financial freedom!
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