OverdraftLineofCredit

What is Overdraft Protection? (Part 3)

What is Overdraft Protection?

(Part 3 of 3)

In part one of “What is Overdraft Protection?” we reviewed how overdraft protection can actually be a few different types of services offered by a bank.

 

  1. A formal overdraft protection “program” that allows overdrafts and charges overdraft fees.  

  2. Overdraft protection from another account.  .

  3. Overdraft protection from a line of credit.

I explained an overdraft protection program in the part 1 of “What is Overdraft Protection?”.  In part 2 of “What is Overdraft Protection” I explained overdraft protection from another account or what’s commonly referred to as an Overdraft Sweep. Please see part 1 or part 2 again if you need a refresher.   In this post, part 3 of 3, I explain overdraft protection from a line of credit.

 

Overdraft Protection from a line of credit.

This type of overdraft protection works with a line of credit previously established with the bank and a lot like an overdraft savings sweep in that overdrafts in your checking account are covered by sweeping in funds from another account.  Unlike an overdraft sweep from a savings account, in which you have the money to cover your checking account overdraft, your overdraft is covered by the bank extending you credit.

 

What’s an overdraft line of credit?

An overdraft line of credit is an agreement between you and the bank in which the bank agrees to give you a certain amount of credit to specifically cover a future overdraft in your checking account.  You will have to apply and qualify for the credit, like you would a credit card, in order for the bank to approve you for it.  I have another post about qualifying for loan for details on the process, but let’s just assume you have been approved for a $1,000 overdraft credit line for the sake of this post.

 

How does an overdraft credit line work?

Once you’ve been approved and sign for your overdraft line credit, the bank will set up a loan account for you.  They will attached the loan account to your checking account and set it to transfer or “sweep” any funds to your checking account to cover an overdraft amount.   Of course, this only happens if you have enough in the credit line to cover your checking account overdraft.  If you have an $1,000 overdraft line of credit, but your checking account overdraft is $1,500, no money will sweep into your checking and you'll most likely get socked with some overdraft fees!  In addition,  the line of credit is something called a revolving line, which means you can pay back any amount you owe and then take it again if it’s needed in the future.  Let’s say you need to use $200 to cover overdrafts, that means you have $800 ($1,000 – $200) left for future overdrafts.   If you pay back $100, that means you’ll have $900 ($800 + $100) available for future overdrafts.

The overdraft line of credit is most beneficial for the bank customers who may accidentally overdraft their checking on a rare occurrence.  The sweep acts like a safety net, just in case something extraordinary happens on their checking account.  Usually they can cover their bills without a problem, it’s just a matter of planning better.   For those of you who may use an overdraft line of credit, a couple of important points to know:

  • It’s not free.  You’ll have to pay the bank interest on any amount you borrow to cover overdrafts and make monthly payments, a lot like a credit card.  Most banks charge about 18% APR, which is a lot, but it’s still cheaper than paying overdrafts fees though!

  • The second point is really important to understand – like a savings account sweep, the sweep only works in batch or total dollars. This means your overdraft credit line must have enough funds available to cover all overdrafts for a particular day, or no money will sweep into your checking account.  I know that may sound confusing, so let’s review an example.  Using the same example as in part one and two of this post, let’s say the below three payments come into your checking and place you in overdraft $170, but your credit line only has $90 left available.   No money will sweep into your checking and you’ll get an overdraft fee on all three payments.  Many people think at least some money will sweep to cover the smaller payments, but the system doesn’t work that way.  If everything works Ok, your checking account activity will look like the below example.

  Debit Credit Balance
Beginning Balance     $50.00
Auto Insurance Payment ($150.00)   ($100.00)
Gym Membership Dues ($20.00)   ($120.00)
Phone Service Payment ($50.00)   ($170.00)
Line of Credit Advance   $170.00 $0

In review, this post detailed the type of Overdraft Protection that sweeps money from a line of credit  to cover overdrafts in your checking account. You need to qualify for the line of credit.  Overdraft line of credit interest is much less than regular overdraft fees, so it will save you money.  Finally, we reviewed how it’s important to understand the batching process that banks use to add all overdrafts for a day and will then “sweep” the total from your credit line only if you have enough credit available.  

 

If you have any questions or comments on this post, email me using the Contact page.  Be sure to read part 1 and 2 on Overdraft Protection types to understand all your options and save the most money on overdraft fees.

BankerX

I’m Banker X and I’m on your side.

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