Checking Accounts and Overdraft Protection
Another type of account offered by a bank is a checking account. A checking account is almost like the opposite of a savings account because the primary function of a checking account is to allow the easy withdrawal and transfer of money, rather than savings. You generally do not earn interest on the money deposited in a checking account.
When you establish a checking account, a bank will issue checks to you that you can use to make payment for goods and services. A check is a negotiable instrument, a piece of paper that can be used as an alternative to cash, that can only be redeemed for money by the person or company you indicate on the face of the check. When you make payment with a check, you specify who should be paid and how much they should be paid. When the check is presented to the bank, the bank will pay this person with cash that is withdrawn from your checking account.
Although this system works very well the majority of the time, there are some instances where the system breaks down. For example, what happens when you write a check for an amount greater than that which you have saved in the bank? When this happens your checking account will go into overdraft. This means that bank has exhausted all the money in your checking account and has used some of its own money to cover your check. Accounts that are in overdraft have a negative amount of money in them, which is to say, you owe the bank money. Any deposits you make into an account in overdraft will be used to pay the bank what you owe. After you have repaid your debt to the bank, your money will be deposited as normal. An example can illustrate how this process works. If your account is in overdraft for $100, and you deposit $500, you will only have $400 in your account when the dust settles, because the bank will have taken the first $100 of your deposit to settle your overdraft debt.
In some instances, the bank will not cover your overdraft. This means that checks you write will not be paid by the bank because there are insufficient funds in your account to cover the check. This situation of having not sufficient funds, is abbreviated NSF. In this case, the bank will charge your account an NSF fee and the person you wrote the check to will not be paid by the bank. You can expect the person to whom you wrote your check to contact you requesting an alternate method of payment. It is also customary for them to charge you for writing a bad check. This is because most banks will charge THEM for backing out the deposit of YOUR bad check. You can see what a mess this sort of situation becomes for all parties. For this reason, it is never a good idea to write a check for more money than is in your account at any given time. Knowingly writing checks without a sufficient balance is against the law.
So, what do you do if you find that you have overdrawn your checking account? First, you will need to make good on the debt. If you do not, there will be legal and financial consequences. Banks generally charge hefty fees on a daily basis while your account balance is negative. Being negative only $10 or $15 can cost you $25 PER DAY, so be careful and take care of this as quickly as you can. Even if you can't pay the money back immediately, talk to your bank to explain the situation and discuss when you will be able to pay off your overdraft debt. Banks may agree to suspend daily penalties in that case.
You will want to take steps to prevent overdrawing your account in the future. You can do this in a few different ways. Chief among these is to track your expenses and account balance so that you do not spend more than you have in your account. Additionally, you will want to set up an overdraft account with your bank.
An overdraft account is a line of credit that is only used when you overdraw your checking account. You can think of an overdraft account as a credit card account without the plastic charge card. When you overdraw your account, money will be transferred from this line of credit and deposited in your checking account to cover your checks. Then you are charged interest on the money transferred from the line of credit and you may be assessed a small processing fee for each time money is transferred.
Another option to prevent overdrafts is to use your savings account as a backup. So, instead of money being transferred from a line of credit, the money will come from your own savings account. Using your savings account as a means of overdraft protection is the preferred method of overdraft protection because there no interest charged when money is transferred from your savings account - it is your own money.