Overdraft

What Is an Overdraft?

An overdraft occurs when a bank or credit union pays a transaction even though the checking account does not hold enough money to cover it. The account balance drops below zero, and the customer owes the shortfall to the bank. Overdrafts can result from checks, debit card purchases, ATM withdrawals, electronic transfers, or automatic bill payments.

How Overdrafts Work

When a transaction posts and the balance is too low, the bank may either approve the payment and let the account go negative, or decline it. If the bank approves it, it typically charges an overdraft fee, and the account stays negative until enough money is deposited to bring the balance back above zero. Some institutions also charge additional fees while an account remains overdrawn. Fee structures differ widely between banks and are described in each account's fee schedule.

Many banks offer overdraft protection, which automatically covers shortfalls by drawing from a linked savings account or a line of credit. These services may carry a transfer fee or interest charge, but they are often less expensive than a standard overdraft fee.

Opt-In Rules and Considerations

In the United States, federal rules under Regulation E require consumers to opt in before a bank can charge overdraft fees on everyday debit card and ATM transactions. Without an opt-in, those transactions are generally declined rather than approved into a negative balance. Checks and recurring bill payments are handled under different rules.

Overdrafts can be costly, especially when several small purchases each trigger a separate fee. Because a single fee can be large relative to the amount overdrawn, the total cost may exceed the cost of borrowing the same amount through a credit card in some situations. Frequent overdrafts can also affect a customer's standing with the bank. For investors, overdrafts are a reminder that cash management affects overall financial health, since money needed for short-term obligations is not available for investing.