What Is an Overdraft Fee?

Want to know one of the quickest (and most annoying) ways to lose money? If you guessed bank fees . . . ding, ding, ding—you got it!

Banks have lots of ways to charge you fees. And some of the worst bank fees you’ll pay are overdraft fees. Paying overdraft fees is like having your bank dip straight into your wallet, pull out a wad of cash, and laugh all the way to, well, the bank.

Overdraft fees are as old as modern banking itself. The story goes that the first overdraft fee was billed to a merchant in Edinburgh, Scotland, in 1728!¹ That’s a long time ago—and banks have been coming up with new and sneaky ways to get those fees ever since.

While overdraft fees may be some of the oldest ways for banks to get money out of your wallet, they’re also some of the easiest fees to avoid. When you build a budget and start telling your money where to go each month, you’re setting yourself up to never pay another overdraft fee.

So, to help get you there, let’s take a look at everything you need to know about overdraft fees and what you can do to kiss those suckers goodbye for good.

How Overdraft Fees Work

An overdraft happens when you spend money you don’t have in your checking account and your balance falls below zero—a big no-no. Your bank or credit union will then charge you an overdraft fee for that.

See, your checking account is basically a digital wallet. It’s where your money lives so you don’t have to carry it around with you. Instead, you can use a debit card—which acts like cash—to pay for the things you buy. The money comes right out of your checking account and makes things super simple and safe. Sounds good, right?

But there’s an important difference between your wallet and your checking account: With cash, you can look in your wallet and see exactly how much money you have. And when it’s gone, it’s gone. With your checking account, if you’re not keeping track, you can literally spend money you don’t have.

Let’s say John has $100 in his checking account. He spends $75 at the grocery store. A few days go by, and he forgets to either jot down the transaction in his checkbook or update his budget tracker. Then his automatic payments for Netflix, Amazon Prime Video and Disney+ come out—totaling $32.47.

The next day when he logs in to his online bank, John notices his account is -$7.47. Not only did John spend $7 more than he had available in his account, but his bank also hit him with a $35 overdraft fee.

Sound familiar? If you know the pain and frustration of overdrawing your account, you’re not alone. In 2020, big banks collected more than $8.8 billion in overdraft fees.² (That was actually down from $11.68 billion in 2019—banks thought they were being nice by waiving some of the fees during the COVID-19 pandemic).³ Now that’s what you call funny business.

Both customers and the federal government are noticing the banking shenanigans. It’s no wonder that several big banks have decided to either cut down or completely get rid of their overdraft fees in response to government investigations and competition from smaller, more customer-friendly banks.⁴

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If you’re already living close to the financial edge, it really stings when those overdraft fees pop up. But this is just one of the many crummy ways banks make their money. What’s worse is that they charge the bulk of the fees to the people who are least likely to be able to afford them. That’s right—just 9% of account holders are on the hook for nearly 84% of overdraft fees.⁵ Nothing like adding insult to injury, huh?

On top of that, it’s possible to get an overdraft fee while you have a pending deposit.⁶ Say you know a transaction will cause you to overdraft, so you deposit a check to cover it. Well, in order to prevent fraud, some banks don’t make your deposits immediately available because they like to make sure the check clears and the money you deposited is actually real. This could leave your deposit in limbo depending on when it’s made.

Overdraft vs. Non-Sufficient Funds

People sometimes use the terms overdraft and non-sufficient funds (NSF) to describe the same fee, but they aren’t the same. Like overdraft fees, you can get hit with NSF fees when you don’t have enough money in your account to cover a transaction.

But the difference is that while overdraft fees allow the transaction to go through so you get charged the fee on top of the transaction amount (putting you even further in the red), NSF fees are charged and the transaction doesn’t go through. So your transaction is declined, and the bank charges you a fee for the “service.” Nice.

NSF fees usually come up with automated clearing house (ACH) transactions rather than point-of-sale purchases (when you buy something from a register). ACH transactions are the payments that come directly out of your bank account using a routing number instead of a debit card.

If you don’t have enough money to cover the automatic transaction, the bank could decline the transaction and charge you for it. If you still use paper checks to pay for things, even at a point-of-sale, you may also get hit with an NSF fee if your check bounces.

How Much is an Overdraft Fee?

Overdraft fees (or you might see them called “insufficient funds” or “non-sufficient funds”) vary from bank to bank. But most range from $20 to $40. And here’s the kicker: Depending on where you bank, you could potentially be charged a fee for every day your balance stays below zero. Or if you make several transactions in a day that overdraw your account, you could be charged a fee for each individual transaction.

Here’s something extra sneaky that banks do to make money off you: Let’s say you use your card five times in one day, but it’s only the last transaction that makes you overdraw your account. Well, your bank can change the order and process the largest transaction first so that more of the smaller transactions send you into the negative. Then they can charge an overdraft fee for each of those charges instead of just the final one. So gross.

And if you think we Americans in the good ol’ U.S. of A. have it bad, it’s even worse in places like jolly old England. In April of 2020, British banks switched over to a percentage rate system instead of a flat fee for overdrafts—with some banks charging as much as 40% interest in fees!⁷ A not-so-jolly way to do business for sure. As the Brits would say, that’s rubbish!

So, when you’re choosing a bank, whether it’s a traditional bank or a credit union or a completely online bank, find out what their overdraft fee policies are before you open your account. Even on the low end, those fees can really add up. And every overdraft fee is money you don’t get to throw at your debt snowball, save for Christmas, or pile into your emergency fund. Besides, if you’re budgeting your money and know where all those dollars are going, overdrafts shouldn’t be an issue.

What is Overdraft Protection?

Most banks offer different forms of overdraft protection or ways to “help” you if you overdraw your bank account. Now, before you go thinking your bank is some kind of do-gooder, let’s break down how these “protections” work.

If you overdraw your bank account and you have overdraft protection in place, your bank may automatically move money from your savings account (or some other linked account or line of credit) to your checking account to cover the difference. But a lot of banks will charge you a fee for this “service” too.

If you’re still using credit cards (which you shouldn’t, by the way), your bank might cover your overdraft by charging it to a linked credit card. Which means you’ll now have debt (not good, especially if you already have some!).

So overdraft protection isn’t a good idea. No matter how you slice it, you can bet your bank isn’t really trying to protect you. And it’s just another reason to cut up those credit cards!

How to Avoid Overdraft Fees

If you’re looking for how to avoid overdraft fees, the simplest answer is to not spend more than you have (what a concept, right?).

While it’s true that the way banks charge fees to their customers can be really gross, they’re ultimately taking advantage of someone’s irresponsible behavior with money—your behavior. It’s up to you to take responsibility for your own finances and keep track of where all those dollars go so you avoid running out of money and stacking up those icky fees.

But the simplest answer isn’t always the easiest. If you’re new to zero-based budgeting (telling every dollar where to go before the month begins), struggle with overspending, or are just starting to get your feet wet with all this money stuff, then it will take some discipline and intentionality on your part to get into a new financial groove.

So, if you don’t want to spend another dime on overdraft fees, the first thing you need to do is get on a budget (our free EveryDollar app makes it easier). Second, use cash or a debit card. Seriously. If you have cash, you always know exactly how much money you can spend at any given time (it’s literally in your hands, after all!). You can do this using Ramsey Solutions’ tried and true envelope system to track your cash purchases.

Debit cards are handy because you have to opt in to the bank’s overdraft system in order to get hit with those fees. If you don’t opt in and then overdraw your account, your card will get declined. Embarrassing? Yes, but at least you don’t have those fees adding salt to your wounded pride.

Bottom Line: Avoid Those Fees with a Budget

Overdraft fees are a way for banks to make a ton of money off people’s mistakes and low bank balances. In fact, the banks depend a lot on overdraft fees to pad their bottom line.⁸

Rather than disabling your account so you can’t overspend, most banks have no problem letting you buy more than you can afford and then walloping you with fees after the fact. It’s gross—really gross. That’s why it’s so important to take personal responsibility for your financial future and budget your money so you avoid those fees in the first place. When it comes down to it, it's up to you to make sure your bank doesn't get any more money from you than it should.