Overdraft protection
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Overdraft protection, colloquially known as bounce protection, is a financial service offered by banking institutions primarily in the United States. Overdraft protection advances money to cover a check written on an account that does not have sufficient funds. This prevents the check from bouncing, which in general carries negative financial consequences in the way of large fines and reduced spending limits.
Costs
Overdraft protection, like all financial services, has a cost. As a source of revenue, banks have the option of charging a fee for every use. Some banks may also treat overdraft protection as a subscription service, incurring a monthly fee irrespective of use. These fees typically range from twenty to thirty dollars USD.There may also be interest costs. Essentially, overdraft protection provides an instant, high-interest loan to cover the amount of the check. This loan is meant to be paid off quickly, as even a short period of inaction can be financially devastating to the customer. Some banks arrange their overdraft protection program to pay the largest check first, in order to increase the number of overdrafts and maximize fee income.
Benefits and risks
If corrected in a timely manner, the costs of overdraft protection are typically lower than the fines incurred for bouncing a check. For a bounced check, the bank will charge the customer a nonsufficient funds fee (NSF) and the cashing institution will charge a returned check fee, sometimes in addition to the amount of the check. This package of fines may be dramatically higher than the single overdraft protection fee.Overdraft protection also has a social benefit, preventing the cashing institution from knowing that the person is low on cash. This is especially useful if the cashing institution is a business partner or relative.
If the overdraw is not corrected, however, overdraft protection may do more harm than good. If the overdraft protection program charges interest for the loan, the interest will accumulate quickly, leading to potential financial ruin. Overdraft protection often causes customers to fall into a "trap" or cycle that is difficult to overcome. This is a similar circumstance to the cycle that occurs in payday lending.