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What Is an Overdraft Line of Credit?

  • by Joseph Priebe|
  • 0 Comment |
  • Updated: March 2, 2022 |
  • Credit

What Is an Overdraft Line of Credit?

If you have an overdraft line of credit with your checking account, it can cover expenses so that you don't miss payments, bounce checks, or have your debit card denied. Some banks may let you use that line of credit to get some emergency cash if you need it.

If you use the overdraft line of credit, you'll pay interest on the amount you borrow. The interest you pay is often less expensive than a standard overdraft protection program, which could charge you up to $35 for each rejected transaction.

This article will help you understand how an overdraft line of credit works, how to get one, the pros and cons, and the alternatives, to help you know if you need one.

How Does an Overdraft Line of Credit Work?

With standard overdraft protection, if you don't have money in your checking account and you make a few small purchases of $4, $12, and $7, you have now overdrawn a total of $28. If your bank charges three $35 overdraft coverage fees, you now owe $105 to cover $28 in purchases. When you have an overdraft line of credit, you borrow the $28 against that line of credit. The bank will charge you interest at a rate comparable to a credit card.

The next time your paycheck is deposited in your checking account, you can repay that loan. With a standard overdraft protection account, your interest charge could be less than $15 instead of $105.

Should I Have an Overdraft Line of Credit?

Not everyone needs overdraft protection, but if you're new to having a checking account or you're learning to manage your money responsibly, choosing this option could be beneficial.

What Fees Can I Be Charged Without a Checking Line of Credit?

Having a cushion of cash is a best practice for your checking account. But sometimes, you could make a mistake, or a forgotten bill can catch you off guard, and when you have an overdraft line of credit, you're covered. If your checking account is empty and you don't have a line of credit linked to your checking account, your penalties can wreak havoc on your budget. Here's a list of penalties that you can incur without a checking line of credit.

Debit card transactions

If you never opted into an overdraft line of credit, your bank can deny any purchases or ATM withdrawals if your account has insufficient funds. You will not be charged non-sufficient funds (NSF) fees because banks do not charge NSF fees for your declined debit transactions. You'll need to decide to use an alternate payment method or not make the purchase. However, if you opt for overdraft protection, you'll avoid the embarrassment of having your transaction denied.

Recurring monthly bills

if you have preauthorized payments withdrawn by Automated Clearing House (ACH), they may be processed by your bank, even if your check account has no funds. Most likely, you will be charged overdraft fees, even if you didn't opt in to overdraft protection. If your ACH transaction is returned unpaid, you'll incur NSF fees. Not only will these cost you $35 for each transaction, but the company that didn't receive your payment can charge you a fee as well.

Checks

If you write a check for more than your checking balance, your bank or credit union might not allow the check to go through. If you have overdraft protection, your check amount will be covered up to your line of credit limit. If not, you may be charged overdraft fees even if your bank covers your check, or your bank may bounce your check, and you can still incur NSF fees, and the check recipient will charge you a bounced check fee as well.

Can My Bank Enroll Me in Overdraft Protection Automatically?

No. The Overdraft Protection Act keeps your bank from automatically enrolling you in an overdraft line of credit. You'll need to request the service.

How Can I Avoid Overdraft Fees?

Like most businesses, the banking industry is focused on making money, and a simple way of doing that is by charging you various fees. Some fees may be unavoidable, but you can avoid most by following these steps.

  • Monitor your account online daily for any unusual activity or spending.
  • Sign up for account alerts via your email or text.
  • Link your checking account to a savings account or line of credit so your bank will transfer money to prevent any bounced checks.
  • Pay with cash and avoid forgetting any debit charge or check you wrote.
  • Use direct deposit to have access to your paycheck quicker.

Before you sign up for a checking account, you need to research a bank's policy on fees. Some banks waive overdraft fees if you deposit the overdrawn amount in 24 hours.

Keep in mind that if you are charged a fee to your account, call your bank's customer service and ask them to waive your fee. It's worth a shot.

How Do I Get an Overdraft Line of Credit?

It's a simple and inexpensive safeguard to add overdraft protection to your checking account. You'll need to contact your bank or credit union to sign up. You may be able to apply online or over the phone. Be sure to research all the fees that you can incur. Once you have the checking line of credit connected to your checking account, use it as little as possible. Keep your line of credit at a manageable amount and your transfer fees and interest charges low.

What Are the Benefits of an Overdraft Line of Credit?

  • Paying an overdraft fee cost will you substantially more.
  • Access to funds that assist you every day or during financial emergencies.
  • If you bounce a check, it will clear and help you avoid returned check fees from merchants.
  • You can qualify for credit limits between $500 to $1,000 or more.
  • Avoid embarrassment and guarantee your transaction will be processed even if your account doesn't have enough money.
  • You can get competitive rates based on your account history or credit history.

What Are the Drawbacks of an Overdraft Line of Credit?

It is true that a line of credit attached to your checking account is less expensive than none at all and that it allows you to spend in emergencies. But it would help if you didn't depend on this form of overdraft protection for these reasons:

  • You could consider a checking line of credit similar to a credit card. If you overspend and depend too much on your credit line, you could end up not being able to afford the charges.
  • Depending on the fine print, your bank could assess a fee for every overdraft transfer and pay for multiple fees in a single day.
  • Your overdraft line of credit is inexpensive, but it's not free. You will pay interest on the money you borrow, and the cost could add up over time.
  • Your financial institution could restrict how times you use your overdraft line of credit and cut you off if you use it too often.

What Are My Alternatives to a Checking Line of Credit?

If you feel that you may not be ready for an overdraft line of credit, you can consider these options:

Don't opt-in

If you don't choose to sign up for the protection, your bank will reject your transactions from your debit card. You won't overdraw your account if you're not allowed to spend more than you have.

Auto transfer from savings

Your bank could allow you to link your savings account to your checking account. Instead of borrowing from your financial institution, you use your cash from your savings account. Be aware of any fees that may occur from this type of transfer.

Link a credit card

If you have a credit card, you could use it to cover any overdrafts that may occur. You'll still owe interest on the amount you borrow, but it will be cheaper than a $35 NSF fee.

Find another bank

If you feel you're being charged too much, it never hurts to shop around online and research other financial institutions.

Does an Overdraft Line of Credit Affect Credit Score?

If your financial institution sends your overdraft line of credit to collections, it will hurt your credit. Once a collection agency creates an account for you, it can go on your credit report as delinquency and remain there for seven years. Be sure to pay off your overdrawn balance with any fees to avoid this issue.

Avoiding collections educating yourself about the factors that hurt your credit score will guarantee healthy finances.

  • Your payment history is the most significant part of your credit score. If you miss or make any late payments, your score will be negatively affected.
  • Your credit utilization should not exceed 30% of your available credit at any time.
  • Your mix of credit account types needs to be diverse with installment loans, lines of credit, and revolving lines of credit.
  • Hard inquiries that appear on your credit report can temporarily ding your score, especially if you have many in a short time.
  • Negative information like foreclosures, charge-offs, debts, and bankruptcies will bring your credit score down.

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