Overdraft Protection

I’ve worked with a lot of people who have overdraft protection, and I hear from many more every month. While there are pros and cons to overdraft protection most people sign up without really understand what they’re “buying.”

Overdraft protection is usually sold to people when their open their accounts as the way to ensure that bounced cheques don’t ruin their credit ratings. When you try to spend money you don’t have in your account, the bank covers the withdrawal – be it a cheque, debit or cash withdrawal.

Don’t confuse the kind of overdraft protection you “buy”, for which you sign an agreement, with what some banks call “bounce protection” or “courtesy overdraft protection” which they offer to save you from the embarrassment or hassle of a returned cheques, which can be very expensive.

The average courtesy overdraft fee runs to about $29 a month, but fees can be substantially higher depending on how undisciplined you are. And since the fee is levied regardless of the amount you go into overdraft for, it can be astronomical when you calculate it as a percentage of the “loan.” One woman wrote me to say that she was appalled when her statement came in and she had over $160 in bounce fees.

Some banks are trying to make their OD protection even more profitable by charging up to $5 for every business day an overdraft is created or increased. So if you go into overdraft on the 12th, you’ll be dinged with a $5 charge. Buy something for a-buck-twenty-five the next day and go further into your overdraft and you’ll be dinged with another $5 fee. Ouch!

I’m all for the traditional overdraft protection for which you sign an agreement so you know what you’ll pay in interest, and for which you pay a flat monthly fee. This is particularly true if you’re in a transition: getting separated or divorced, moving, changing jobs. An overdraft protection plan beats the pants of NSF fees and the bruise on your credit report. And it is far less expensive than the pay-as-you-go option.

What I’m not down with is the idea that overdraft protection gives people a license to ignore their cash management. No, you can’t spend whatever you want, whenever you want, because overdraft protection is there to catch you like a safety net. And you’re not allowed to live in overdraft, squeaking into the black for a couple of days twice a month when your paycheque passes through your account.

While some of you might think, as I do, that overdraft protection is a short-term affair – most overdrafts are said to last only about 5 days or less – I’ve met oodles of people who practically live in overdraft.

And, ya know what? The banks don’t mind one little bit when you go into overdraft, since overdraft interest rates are well above regular lending rates. One bank I checked charges 21% interest on your outstanding overdraft balance, along with the fee that going into overdraft automatically triggers.

Despite being extremely profitable for banks, lenders can sometimes get testy if you stay in overdraft too long. Read the paperwork. Often there’s a clause that says you can’t stay in overdraft for more than a certain number of days each month. Break the rules when money is flowing easily and no one much minds. Break the rules when credit is tight and banks are feeling the pinch and they’ll call your overdraft, demanding their money back lickety-split. Yes, they can do that.

If you’re scratching your head because the rules seem to change depending on the wind, you’re right to be confused; just know the cards are stacked in favour of the bank. After all, if overdraft is just for the odd slip as the marketing material says, then why do some banks offer the option of going $5,000 or more into overdraft? That’s NOT a little slip.

Except for those transitional times when slips are natural, overdraft isn’t the great solution your banker makes it out to be; the better solution is to manage the cash in your account so you don’t try to spend money you don’t have.

How do you do that? Easy. You use a spending journal to track what’s going into and coming out of your bank account.

Get yourself a notebook. When you put money in your account, add it to your balance. When you spend money from your account (be it a cheques, on-line bill payment, debit card transaction, or cash withdrawal) you debit that amount from your balance. Keep your eye on the balance.

If you think that sounds like too much work, you’re a dope. You’d work at least this hard to find where gas is selling for a penny less, or where tuna is two for $1.59, or where wings are all-you-can-eat for $3.99. Staying out of overdraft is one of the best deals going.