What Is an Overdraft? Fees, Types, and Overdraft Protection

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An overdraft occurs when a bank lets a payment or withdrawal go through even though the account does not hold enough money to cover it, pushing the balance below zero. The negative amount is money the bank has effectively lent you, and the account stays “overdrawn” until deposits bring it back above zero. Banks usually charge for this short-term credit through a flat overdraft fee, interest, or both.

How an overdraft works

When a transaction reaches your account, the bank compares it with your available balance. If the balance is too low, it has three choices: decline the transaction, return it unpaid, or pay it and let the account go negative. Paying it is the overdraft.

What happens next depends on the type of coverage attached to the account:

1. Pay and charge a fee. The bank covers the item and charges a flat overdraft fee for each transaction it pays. At some banks this fee has run upwards of $30 per item, so several small purchases on one day can produce several fees.
2. Transfer from a linked account. Overdraft protection pulls money from a linked savings or checking account to cover the shortfall. The bank may charge a transfer fee, usually smaller than an overdraft fee, or none at all.
3. Draw on a credit line. An overdraft line of credit lends the missing amount and charges interest on the outstanding balance, typically quoted as an annual percentage rate (APR), until you repay it.

If the bank declines or returns the item instead, it may charge a non-sufficient funds (NSF) fee, and the merchant or payee may add its own returned-payment charge.

The negative balance is repaid automatically from your next deposits, so a paycheck goes first to the deficit and any fees, leaving less money for upcoming bills.

Types of overdraft

Standard (courtesy) overdraft coverage. Some banks, though not all, pay overdrafts at their discretion and charge a fee for each one. The bank is under no obligation to cover any given item, and it can withdraw this service if an account overdraws frequently.

Overdraft protection (linked account). Because the money comes from another of your own accounts, there is no loan and no interest, and coverage is limited by what the linked account holds.

Overdraft line of credit. A pre-approved, revolving credit line tied to checking that usually requires an application and credit check. Interest accrues daily on what you use, and paying it down restores the limit.

Arranged overdraft facility. In the UK, many other markets and business banking, an “overdraft facility” is an agreed limit up to which the account may go negative, priced with interest rather than per-item fees. Exceeding it is an unarranged overdraft, usually more expensive or declined.

ATM and debit card overdrafts. An ATM overdraft happens when a cash withdrawal takes the account below zero. Under the US Federal Reserve’s Regulation E rules in effect since 2010, banks may not charge overdraft fees on ATM withdrawals or one-time debit card purchases unless the customer has opted in. Without opt-in, those transactions are normally declined at the terminal. Checks, ACH payments and recurring debit card charges fall outside that opt-in requirement.

Example of an overdraft

Hypothetical example; fees and rates are illustrative, not any bank’s terms.

Maria’s checking account shows $50. On the same day, a $40 grocery purchase and a $30 utility autopay both post.

• After the grocery charge, the balance is $10.
• The $30 autopay overdraws the account to −$20.

Scenario A, standard coverage at a $35 fee per item: The balance becomes −$55 ($20 deficit plus $35 fee). Maria paid $35 to borrow $20 for a few days, which is extremely expensive in annualized terms.

Scenario B, overdraft line of credit at 18% APR: The bank lends $20. If she repays it in 10 days, simple daily interest on a 365-day year is $20 × 0.18 × 10 ÷ 365 ≈ $0.10, plus any transfer fee the bank charges.

Scenario C, linked savings account: $20 moves from savings into checking, and the balance returns to zero. The only cost is whatever transfer fee applies.

Overdraft fees and the rules around them

Overdraft fees are often similar in size to NSF fees. Some banks charge neither, and some cap the number of fees per day.

Several regulatory actions in the US shape how these fees can be applied:

• Transaction ordering. Posting the largest debit first can drain a balance quickly and turn several small items into separate overdrafts. In 2010 a federal court ordered Wells Fargo to pay $203 million over reordering withdrawals in a way that maximized overdraft fees.
• “Authorize positive, settle negative” fees. In 2023 the Consumer Financial Protection Bureau (CFPB) found that some banks charged overdraft fees on purchases approved while the account had enough money, which later settled after other transactions had pushed it negative. The CFPB described these fees as ones consumers could not reasonably avoid and directed banks to stop them.
• Cost of coverage. A 2017 CFPB report found that customers with overdraft coverage often paid more in fees than those without it.

Does an overdraft affect your credit score?

A checking account is a deposit account, not a credit account, so an overdrawn balance is not reported to the credit bureaus. The risk comes later. If the negative balance and fees go unpaid, the bank may close the account and sell or assign the debt to a collection agency. A collection account can be reported to Equifax, Experian and TransUnion and can lower your score.

Overdraft protection linked to a credit card or credit line works differently. Those draws add to a credit balance, and higher utilization or missed payments on that account can affect your score directly. Separately, unpaid overdrafts can be recorded with checking-history reporting agencies, which some banks consult before letting you open a new account.

Pros and limitations of an overdraft

Advantages

• A rent check, loan payment or bill goes through instead of being returned, which avoids merchant returned-payment fees and late charges.
• A linked-account transfer or credit line can cost far less than a per-item fee, and an interest-based overdraft line may be cheaper than carrying a credit card balance for a short period, depending on the rates involved.

Limitations

• Flat fees are unrelated to the size of the overdraft, so a small purchase can carry a large charge.
• Repeated overdrafts can lead the bank to remove coverage or close the account.

Overdraft vs. similar terms

Overdraft vs. NSF: An overdraft means the bank paid the item. NSF means it refused, and the payment bounced.

Overdraft vs. line of credit: A general line of credit is drawn on deliberately. An overdraft line is triggered automatically when checking goes below zero.

Overdraft vs. cash advance: A cash advance borrows against a credit card’s limit, usually at a higher rate with its own fee. It is not tied to your checking balance.

Overdraft vs. demand draft: A demand draft (bank draft) is a prepaid instrument the bank issues after taking the funds from your account. It cannot overdraw anything, so it is close to the opposite of an overdraft.

Bank overdraft in accounting

On a company’s balance sheet, a bank overdraft is a current liability, because the business owes the bank money repayable on demand. The overdrawn cash account carries a credit balance and is reported as a liability rather than netted into cash, except where accounting standards allow overdrafts repayable on demand to be included in cash and cash equivalents on the cash flow statement. For the bank, the overdrawn amount is an asset: a loan receivable from the customer.

FAQs

The Bottom Line

Anyone with a checking account that sometimes runs low should know which overdraft coverage is attached to it. Per-item fees can make a small shortfall very costly, while a linked savings account or an overdraft line of credit usually costs far less. Repaying a negative balance quickly limits fees and protects against account closure and collections.