If you are known to bounce a check from time to time, you need a system in place to keep you from paying hefty fees.
If your bank offers overdraft protection, should you use it? Perhaps, but be aware of what protection you're signing up for. “Bounce coverage” for many people can be a waste of money.
Overdraft protection is an agreement that if you make a payment that exceeds your bank balance, your bank will pay the merchant automatically. Essentially, it's a very temporary loan from your bank, so you can stay in good standing with the seller and avoid a returned-check fee from the merchant.
A bounced check with no protection usually results in a $20 to $30 fee from the bank, as well as a $20 to $30 fee from the merchant. With the typical overdraft protection plan, this penalty is cut in half – you only have to pay the bank's fee so long as you put money back into the account quickly.
Still, that's $20 to $30 that you have to pay for the error – no small potatoes if you overdraw your account a few times a year, or if you are swiping your debit card for an entire weekend without knowing that your account is overdrawn. (Each overdraft prompts a separate fee.)
The best option for most people – and one that most banks offer, according to the online service Bankrate.com – is to link a savings account to your checking account. The cost of a transfer is about $5 to $10, much less than the usual overdraft fee.
“You have to specifically ask for it, but it's more than worth it,” said Greg McBride, senior financial analyst at Bankrate.com. “Sooner or later, everybody's going to slip up once. It's great peace of mind.”
If you don't have a savings account at your bank, start one for this reason, McBride recommends. Socking away $100 or $200 in a linked savings account could save you that much in overdraft fees in the long run.
Another choice is to link your checking account to your credit card. This way, you get a cash advance for a nominal fee that goes into your checking account to prevent you from overdrawing. This plan is only good for people who pay off their credit card balances regularly; the interest rate on the cash advance can spike over a fairly short period of time.
You can also set up an overdraft line of credit with your bank – the bank will then use this line of credit to cover any overdraft. Check out the terms that your bank offers on this type of system – it might be cheaper than the usual overdraft protection.
“You will pay interest on this loan, and there may be an annual fee,” the Federal Reserve notes on its Web site. “But the overall costs may be less than the costs for courtesy overdraft-protection plans.”
Of course, the best way to cut down on overdraft fees is to not overdraw at all. But since accounting mistakes can happen to even the most financially savvy – especially given the growing popularity of automatic electronic payments and debit cards – it's best to plan ahead.
