Bank and credit union customers wondering how overdraft works should be wary of the risk of getting hit with multiple overdraft fees

Overdraft protection is now offered at a number of different financial institutions. Here’s how overdraft works, in a nutshell: In the past, a bank or financial institution would conventionally refrain from honoring a transaction given insufficient funds. But how overdraft works is that instead of declining the transaction, the bank or credit union pays it on the customer’s behalf, or transfers funds from a linked savings  account to cover the transaction.

If you have ever written a check or used a debit card without having sufficient funds and incurred a fee, without the transaction being declined, then you’ve utilized the bank’s overdraft protection service.

How overdraft works may help the bank customer in many ways. For one, it helps pay for expenses when you have insufficient funds in your account. This can get you out of trouble when you really don’t have the funds during a point of sale transaction or to cover a check. Without overdraft protection, your transaction would be declined.

There are also different types of overdraft protection that a consumer may utilize. Fees may be charged differently with each type although the service still transfers funds to your account in the event of an overdrawn checking account.

One type is to opt in for overdraft coverage for ATM and one-time debit card transactions. In this way, you allow the financial institution to cover ATM overdrafts and one-time debit card transactions.

Another type of overdraft is to opt in for overdraft coverage using a linked to a line of credit. In the event of an overdrawn account, the funds used to cover the transaction will be assessed to your line of credit.

Third, you may be eligible to link your account to secondary checking accounts, savings accounts, or money market accounts. Funds from those accounts can be transferred to your checking account to cover transactions that would have otherwise caused an overdraft.

However, there are some drawbacks to utilizing an overdraft protection service. The main drawback is that a bank will charge an overdraft protection fee for each transaction. Typical overdraft charges are $34 per overdraft item. About $10-$12 is also applied to overdrawn checking accounts that are linked to secondary checking accounts, savings account, money market accounts or lines of credit.

More fees may apply if the customer doesn’t quickly return their account to good standing. Extended overdraft charges may apply if the account is overdrawn for a certain number of days.

Customers who don’t understand how overdraft works are at risk for incurring a big balance in fees if they don’t keep an eye on their account balance. In this case, a customer may be charged hundreds of dollars for small banking transactions that overdrew the consumer’s bank account in the first place.

According to recent reports, moreover, many banks have been accused of improper overdraft practices. Capital One, HSBC Bank, and many other financial institutions have been accused of posting transactions in the order that maximizes the number of overdraft fees.

By posting a transaction in the order of greatest amount, instead of the order in which the transaction was made, the bank can deplete the customer’s account sooner. Therefore, if a consumer makes a transaction of a very large amount, which thereby overdraws their account significantly, a bank might want to post that transaction first, rather than one with a smaller amount, so that each subsequent transaction made thereafter is charged an overdraft protection fee.

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