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Overdraft Protection: Overpriced Peace of Mind?

April 9, 2013
3 mins
A young woman sits on her couch, drinking a coffee and scrolling on her phone in bright, trendy downtown apartment

Here's the thing with electronic banking - it's supposed to make our lives simpler, - and while it may be convenient to pay your bills online, between your mortgage, utilities and Internet service, it’s easy to forget about the countless pre-authorized payments we have coming out of our bank accounts. That’s where overdraft protection is supposed to come to the rescue but is it a true necessity or just an overpriced insurance policy?

What is Overdraft Protection?

As the saying goes, hindsight is 20/20. All it takes is one costly not sufficient funds (NSF) charge for you to wish you had overdraft protection. Last month I made a lump sum prepayment on my mortgage – the problem was that the payment wasn’t for another two weeks and by that time I made a large purchase on my debit card and was $200 short. Not only did I have to pay a $45 NSF charge to my bank, I also had to pay a $65 charge to my mortgage lender – ouch!

If you've ever been out shopping and have been declined at the cash register due to insufficient funds, you're familiar with the embarrassment. Overdraft protection is designed to allow you to temporarily draw more money from your account than you actually have - but it comes at a price.

Types of Overdraft Protection

Overdraft protection typically comes in two forms: monthly fee-based and pay as you go. The monthly fee option is ideal if you write a lot of cheques and don’t want to worry about them bouncing. Pay as you go is ideal for those once in a blue moon occasions for when you write a cheque, but you’re short of the funds – instead of paying an insufficient funds charge, which can be as high at $45, you’re only on the hook for a lesser amount of typically $5. It may sound like a no-brainer to get overdraft protection - but your bank probably isn’t telling you the whole story.

The Hidden Costs of Overdraft Protection

You might think your bank is doing you a favour when they offer your overdraft protection. Think again. The big banks make a fortune off overdraft charges. Last year TD Bank made $1.8 billion from just service charges. That's because overdraft protection interest charges are often comparable to payday loans, which can charge as much as 21 per cent interest per $100 in only two weeks. If you’re considering overdraft protection it’s important to read the fine print.

How to Keep your Bank Account in the Black

The best way to avoid overdraft protection is to carefully manage your bank account. That’s easier said than done, especially if you have a joint account with your spouse. Similar to how it’s a good idea to have an emergency fund of at least three month’s living expenses, it’s also a good idea to keep at least $1,000 in your chequing account – that way if you write a cheque and forget about it you’ll have enough money to cover it. Another way to avoid overdraft protection is to pay with your credit card instead of your debit card. Not only will you avoid going overdraft, a lot of credit cards like the MBNA Smart Cash MasterCard offer points which can be redeemed for cash back and groceries.

Not To Be Relied On

It's easy to lose sight of what overdraft protection is for. It’s not supposed to be used like a credit card or line of credit for frivolous purchases, it’s to protect you from the odd time you write a cheque and forget about it. By managing your bank account properly and leaving a reserve of at least a few hundred dollars you can avoid overdraft protection all together and keep your money where it belongs – in your pockets, not the bank’s coffers.  

Sean Cooper

Sean Cooper is the author of the new book, Burn Your Mortgage. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Financial Journalist, Speaker and Money Coach, his articles and blogs have been featured in publications such as The Toronto Star, Globe and Mail, Financial Post, Tangerine: Forward Thinking blog and TheDot. You can follow him on Twitter @SeanCooperWrite.

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