What Is Overdraft Protection?

Overdraft protection is a service offered by banks that issues you a short-term loan when you make a purchase with your debit card or write a check for more than your balance. However, the service comes at a cost, and it can sometimes be far more expensive than having the purchase denied.

Overdraft Protection Function

When you write a check or make a purchase with your debit card, you must have at least the amount of the purchase in your bank account, otherwise the transaction will be rejected. For example, if you try to make a $30 purchase and your account only has $20 in it, without overdraft protection, your purchase will be denied. However, if you have overdraft protection, your bank makes a loan to you to cover the last $10 of the purchase.

Costs of Protection

When you overdraw your account, the bank will generally charge you a fee, regardless of by how much you exceeded your limit. In addition, you will be charged an additional fee if you don't repay the overdrawn amount within a certain time period. For example, one bank may charge you $38.50 to cover an overdraft and an additional $38.50 if you don't replenish your account in five business days. So, overdraft protection can be a costly way to prevent your card from being declined at the register.

Must Opt-In for Overdraft Protection

If you want overdraft protection to apply to your account (and are willing to pay the fees that come with it), you must opt-in with your bank. Prior to 2010, banks would automatically enroll you in their overdraft protection services, according to Bankrate.com, and when you overcharged your account by just a few dollars, you would get slapped with fees rather than having the purchase declined.

Avoiding Overdrafts by Tracking Spending

Tracking your spending can be a cheaper alternative to signing up for and using overdraft protection for your accounts. In addition, taking an active role in monitoring your spending allows you to figure out where your money is going -- and whether you would prefer that your money be spent or saved elsewhere. Consider using Quicken personal finance software to keep tabs on your spending habits so you can avoid overdrawing your accounts in the first place.

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Tip: To find out which version of Quicken you are using, open Quicken go to Help menu and select About Quicken.