What are overdraft fees & how are they calculated?

What Are Overdraft Fees, and How Are They Calculated?

When it comes to managing bank accounts, most people fall into one of two camps: they check their balance frequently and double-check every charge, or they rarely check their balance and take an “out of sight out of mind” approach. If you fall into the former camp, you know where each penny goes, and if you fall into the latter, you could be racking up bank fees you don’t even know about.

Overdraft fees have hit most people at one point or another. Perhaps they’re the reason you began banking with KOHO (we’re fee-free). If you haven’t made the switch, or even if you have, it’s important to know what overdraft fees are, why they’re charged, and what you can do to stop them.

What are Overdraft Fees?

Overdraft fees are fees that your bank or financial institution charges you when you overdraft your account. For example, if you make a purchase with your debit card that is $125 but you only have $100 in your account, you will be charged an overdraft fee – assuming your financial institution charges them (KOHO doesn’t).

Overdraft fees vary from bank to bank; they can be as low as a few dollars or as high as 35 dollars. These fees apply to any purchase made with your debit card or cheque, and any withdrawal or transfer from your account that is greater than the account balance.

The fee is the bank’s way of offering you overdraft protection. Overdraft protection means you will still be able to complete a transaction, rather than it being declined due to insufficient funds. While “protection” may sound like a nice benefit offered by your bank, and it may save you embarrassment at the checkout counter, it’s really just another way for the bank to make money off of your account, and another way for you to end up buying more than you can afford.

At KOHO, we send you a friendly notification to let you know you don’t have sufficient funds in your account. Plus, you can check your account easily on our app to ensure you have enough funds before you reach the checkout counter in the first place.

How Overdraft Fees Work

Say you’re still with your traditional bank. That’s ok! But you should know how its overdraft fees work. Every traditional bank has different terms surrounding overdraft fees, but there are two main types: monthly fees and pay-per-use fees.

A bank may charge you an overdraft fee of $5 every time your balance is overdrawn. Or, a bank may charge you a monthly fee for overdraft protection. This fee is typically around $5 a month, rather than per transaction. In many cases, you need to apply for overdraft protection.

Let’s go back to the example above. If you made a purchase for $125 when you only had $100 in your account, you will have a negative balance of $25. Let’s assume your bank charges pay-per-use overdraft fees. Add the overdraft fee, of say $5, and you will have a negative balance of $30. Then, you go grab a coffee and a pastry for $8. Your balance will decrease to a negative $38 and—here’s the kicker—you’ll be charged another overdraft fee of $5, taking your account balance to a negative $43.

If you have pay-per-use overdraft fees, you will continue to rack up the $5 fee with every transaction until your account balance is back in the black. If you have monthly overdraft protection, you will be charged $5 per month, regardless of how many times you do or don’t overdraft your account.

But wait… there’s more. In addition to the per-transaction or per-month fee, you will also be charged interest on the amount of money you overdraft. This is based on an annual interest rate set by the bank, usually between 19 and 22 percent. It’s important to read the terms of your banking agreement to understand what type of fees you will be charged and when, and the interest rate on the amount you overdraft. Many banks won’t make the rules explicit, which is how overdraft fees can be predatory, and why we don’t charge them.

Overdraft Fees vs. Non-Sufficient Funds Fees

Overdraft fees and non-sufficient funds (NSF) fees are often used interchangeably, but they aren’t the same thing. Similar to overdraft fees, NSF fees are charged when you don’t have enough funds in your account to cover the cost of a transaction. However, NSF fees are much more expensive than overdraft fees, often around $50. Again, it’s important to read your banking agreement to know when you’ll be charged NSF fees and how much they are.

In case you’re wondering, we don’t charge NSF fees at KOHO either.

How To Avoid Overdraft Fees

When you’re low on cash, every little bit counts, so don’t go into overdraft if you don’t have to. Additionally, if you incur too many overdraft fees, banks could cite it as a reason to close your account. Here are a few helpful tips to keep you out of the red.

Keep a Minimum Balance in Your Account

If your bank account is running low, you’re in danger of triggering an overdraft fee. While everyone slips up every now and then, those with consistently low account balances are more prone to be hit by overdraft fees not just once but over and over again. One study found that 84 percent of all overdraft fees were paid by just 9 percent of account holders. The majority of those hit by fees tended to carry less than $350, on average, in their account.

You don’t have to wonder if a stop at a coffee shop will cost you more than it says on the receipt if you keep a minimum balance in your account. We suggest at least $500, but if you are funding all of your bills, rent included, out of this account, you will need at least twice that much.

Change Your Auto-Pay Dates

Auto-pay is a great way to ensure you always pay your bill on time, but it can also be a reason you overdraft your account unintentionally. To avoid this common mistake, you can change the due date of your bills (yes, even your credit card payments) to fall after payday. This will ensure you always have enough money in your chequing account to fund your regular expenses.

Stick to a Budget

If you’re overdrafting your account more often than not, these tips aren’t going to help you much in the long run. What you really need is a budget, and to stick to it. Part of avoiding additional fees, staying out of debt, and managing your money well is spending less than you make each month. In order to do this, you have to know how much you have coming in and how much you have going out. Download our budget template, and start tracking your income and expenses.

Allocate your income to all essential spending, such as rent, utilities, and food, first, and then to important spending such as saving and investing. Then, with what is left over, you can budget for discretionary spending such as entertainment, shopping, and eating out. When you stick to a budget and keep a minimum balance in your account at all times, you won’t be in danger of incurring overdraft fees.

Reevaluate Your Bank

Not all banks are created equal, which is important to note, especially if you’re opening your first bank account or just trying to make smart financial decisions. Banks are also always making changes to their fee structure and benefits. For these reasons, it’s a good idea to continually reevaluate where you bank. And, if you’re being charged too many fees, it’s time to look for a better option now.

KOHO is a great free option for you. It allows you to house your savings and chequing accounts, earn interest and rewards, and get your hands on a prepaid reloadable prepaid credit card, all without surprising charges or hidden fees. If you do attempt to make a transaction that you don’t have the money for, you’ll get a friendly notification that there aren’t enough funds in your account. Plus, with KOHO, you can access the tools and support you need to continue to uplevel your financial health.

What to Do if You’re Charged an Overdraft Fee

Getting charged an overdraft fee feels like getting kicked when you’re already down. Even if you rarely check your account balance, you’re probably aware you’re short on funds, and that few-dollar fee can feel monumental at the moment. In other cases, the fee is just annoying because you know it could have been easily avoided. While you can avoid overdraft fees altogether by signing up with KOHO, there are some steps you can take with your current bank if you’re charged an overdraft fee; if you act soon, it’s possible to get overdraft fees waived.

Talk To Your Bank

If it’s your first time overdrafting your account, it’s worth it to call up your bank and explain the situation and ask for a refund. You’d be surprised at how many banks offer one-time refunds to account holders or ongoing assistance in special circumstances. Given the financial hardship the Covid-19 pandemic has caused, many banks are even more likely to work with you, providing fee waivers, deferred payments, and other assistance.

If you’re a repeat over-drafter, this tactic probably won’t work. Instead, follow our advice above and do your best to stay out of the overdraft range from here on out. Better yet, sign up for a fee-free account. If you do, you could save a great deal of money on fees.

Learn From Your Mistakes

If you can’t get your overdraft fee waived, or even if you can, it’s important to consider why you overdraft your account in the first place. Was it because you’re living paycheque to paycheque and need to drastically reduce your spending to build up a steady account balance? Or was it because you had one too many bills come out of your account automatically on the same day? Determine the reason and follow our tips above to address it so it doesn’t happen again.

Overdraft fees are annoying, but they are avoidable. Make a conscious effort to keep a minimum balance in your account, plan your bill-pay dates, stick to a budget, and consider moving to an overdraft-fee-free bank like KOHO. If you take these steps, you’ll steer clear of these pesky fines in the future.