Is It Illegal to Overdraft Your Bank Account?

Overdrafts: Legality and Bank Procedures

Overdrawing a bank account is not considered a criminal offense in the United States. Instead, it is typically viewed as a breach of the contractual agreement between the account holder and their financial institution. An overdraft occurs when a transaction exceeds the available balance, creating a negative balance.

Financial institutions generally handle overdrafts in one of two ways. They may pay the transaction despite insufficient funds, often charging a fee. Alternatively, the bank might decline the transaction, preventing a negative balance and potentially charging a “returned item” or “insufficient funds (NSF) fee.”

Many banks offer “overdraft protection.” This optional service links a checking account to another account, such as a savings account or a line of credit. When an overdraft occurs, funds are automatically transferred from the linked account or credit line to cover the transaction.

Federal regulations, specifically Regulation E, govern how banks charge overdraft fees for debit card and ATM transactions. Banks must obtain explicit consent, or “opt-in,” from the account holder before charging fees for paying overdrafts on these types of transactions. Without this opt-in, banks are prohibited from charging a fee for paying a debit card or ATM transaction that overdraws an account, and must instead decline the transaction.

Financial Repercussions of Overdrawing

When an account goes into overdraft, the bank imposes fees. Overdraft fees typically range from $20 to $35 per transaction. Some banks charge continuous overdraft fees if the account remains negative for an extended period, adding an additional daily charge until the balance is restored.

If a check or electronic payment is returned due to insufficient funds, the bank may levy a returned item fee, similar in cost to an overdraft fee. The merchant or payee may also charge their own returned item fee. These charges can quickly accumulate.

Repeated or severe overdrafts can lead to the bank closing the account. Account closure can disrupt an individual’s ability to manage their finances, making it difficult to pay bills or receive direct deposits.

Banks report negative account activity, including unpaid overdrafts and account closures, to consumer reporting agencies like ChexSystems. A negative report with ChexSystems can significantly impact an individual’s ability to open new checking or savings accounts at other financial institutions for several years. This can force individuals to rely on alternative, more expensive, financial services like prepaid debit cards or check-cashing services.

Preventing Account Overdrafts

Regularly monitoring account balances is a foundational step to avoiding overdrafts. This can be accomplished through online banking portals or mobile banking applications provided by most financial institutions. These platforms offer real-time access to transaction history and current balances.

Maintaining an accurate record of spending and reconciling transactions against bank statements or online activity helps prevent unexpected shortfalls. This involves tracking all debits, including checks, debit card purchases, and automated bill payments, to ensure the recorded balance aligns with bank records. Discrepancies can then be investigated.

Many banks offer notification services that alert account holders when their balance falls below a predetermined threshold. Setting up low-balance alerts via email or text message provides a timely warning, allowing individuals to deposit funds before an overdraft occurs.

Establishing overdraft protection by linking a savings account or a personal line of credit to a checking account is another measure. This setup automatically transfers funds to cover transactions that would otherwise overdraw the checking account.