Do you need overdraft protection?

Posted by admin on March 23, 2009 in Investment Products

Congratulations to Geoff who won last week’s draw. Look for more draws coming up in the spring.

Overdraft protection is an often misunderstood banking product. As Ellen Roseman’s recent article on overdraft protection indicated even judges have difficulty understanding the product. First and foremost, overdraft protection is not a line of credit (even though it works in a similar manner).

Instead, overdraft protection is a short-term coverage by the bank when there are insufficient funds to cover cheques, debit purchases and electronic transfers. One of the purposes of overdraft protection is to protect an account holder in the event a bank account has a low balance and there are more withdrawals going out than there is money to cover (with the assumption that a pay cheque or money would be deposit shorter thereafter to bring the balance bank above $0).

Most overdraft protection I have seen are for coverage of up to $5,000- $10,000 (in other words you can have a balance of – $10,000 in your bank account). However, the overdraft has to be repaid within a short period of time (I have seen as little as 30 days to 89 days to 6 months) or punitive interest will be applied (credit card rates and over).

Fees can vary. Some financial institutions charge a monthly fee which is less than the amount of NSF fees which would be charged if you bounced a cheque. There are now also “pay as you” policies now for ocassional users of overdraft protection.

The key though is not to treat your overdraft protection like a line of credit since the repayment period is relatively short and the interest rates sky-high. As Ellen’s article states once you start treating your overdraft protection like a line of credit, the bank treats you as a delinquent customer.

From a practical perspective, it also make little sense to use overdraft protection as a short-term line of credit given it is an extremely expensive financing source- as strange as this sounds, in some cases, it is cheaper to finance using your credit card than overdraft protection.

In other words, overdraft protection should be used if you typically keep a low bank balance but have frequent withdrawals. If the bank tries to sell you more overdraft protection ask instead for a greater line of credit instead. As always, read the terms and conditions of your overdraft protection since they are amended often and banks, in this day and age, are not very lenient if you are in default.

2 Comments on Do you need overdraft protection?

By tom on March 23, 2009 at 8:20 am

Agreed, overdraft becomes misused when you are struggling to get a grip on your finances and I speak from experience.

But the moment you had an emergency fund and/or savings, you don’t need to worry about that.

I know that the fee is 5 dollars plus interest compared to no protection then NSF fee is 40 bucks.
Which I still think either way is stupid, and a way for banks to make easy money.

By Riscario Insider on March 24, 2009 at 1:06 am

For a few months, I was being “clever” by keeping a minimal balance in our low interest chequing account. We kept more money in a higher interest savings account and transferred back and forth. I messed up a couple of times. Overdraft protection saved the day by preventing cheques from bouncing. The penalties were more than the (taxable) interest earned in the savings account. Now we keep an ample cushion in our chequing account but have not cancelled the overdraft protection.