How Do Overdrafts Happen?
No matter what you call it—hot check, bounced check, insufficient item or overdraft—when you spend more than you have in the bank, it can be costly. If the item is a check, the bank will choose to either return the check or pay it and overdraw your account. Whether the check is paid or returned, a fee may be charged by the bank. In addition, some merchants charge a fee for returned checks.
ATM and debit card transactions work differently. When you open your checking account, the bank will provide you with the option of overdraft privilege on electronic transactions. This is an important decision. While overdraft privilege can help you avoid declined transactions in an overdraft situation, it may also allow electronic overdrafts on your account, which could result in a fee. Not only can overdrafts be costly, but they can negatively affect your banking record.
- Keep a Register: record transactions in a register as they occur, and keep a running balance. Remember to record any automatic payments. For recording on the go, there are many check register apps available.
- Balance Your Account: regularly use the form on the back of your statement or our Account Balancing Form to balance your account regularly.
- Make Your Deposit First: avoid trying to beat a transaction to the bank with a deposit to cover it. Today, the race is hard to win. With check imaging and electronic transactions, payments can post almost immediately.
- Don’t Rely on a Balance Inquiry: a balance inquiry you receive from an ATM, Internet banking, mobile banking, or by phone may not include all recent transactions.
- Use Internet Banking: keep a close watch on your account with Internet banking. Rather than waiting for your monthly statement, balance your register to the Internet banking transaction journal as frequently as needed.
- Sign Up for Automatic Notifications: take advantage of customized email and text alerts to notify you when your daily balance falls below a specified minimum amount, or when a direct deposit is received.
- Use Mobile Banking: view your account balance and transaction history with your web-enabled mobile device anytime, anywhere.
- Use Direct Deposit: many employers provide the option of having your paycheck deposited directly to your account. This is the quickest way to get access to your funds.
- Create a Buffer: keep an extra amount or “buffer” in your account, and never let your account balance fall below this amount. A buffer can help you avoid an overdraft caused by a math error or accidently overspending your account.
Sign Up for Overdraft Protect: Overdraft Protect links your savings account to your checking account. Funds are automatically transferred from your savings account to your checking account to cover an overdraft.
Balance inquiries can be obtained through online banking, mobile banking, ATMs, or by phone. However, beware of relying solely on a balance inquiry to determine your account balance. You may have transactions that have not cleared the bank.
All transactions do not clear your account the moment you conduct them. A check could take 10 minutes or several weeks to clear your account, depending on the actions of the payee. If the payee promptly cashes the check at your bank, it will clear immediately. If the payee holds onto the check for a time, or deposits the check at his bank, it will take longer to clear.
How Debit Card Transactions Affect Your Balance
Debit card transactions may not be deducted from your account immediately. The merchant and the type of transaction affect the speed of processing. Understanding how different debit card transactions work can help you avoid problems with your checking account.
Personal identification number (PIN) transactions, such as ATM withdrawals, require you to enter a PIN via a PIN pad, rather than requiring your signature. PIN-based transactions are processed through an online network, and typically post to your account immediately.
Payments authorized without a PIN, such as signature purchases, some pay at the pump swipes, and online purchases, are processed by the merchant in two steps: 1) authorization, and 2) settlement. When your card is swiped, the merchant receives an authorization and a “hold” is placed on your account to reserve the funds for the amount of the transaction. This authorization hold appears on your online banking transaction history and reduces your available balance. The hold remains on your account for a specific number of days or until the actual transaction clears.
Payments authorized without a PIN can take longer to process because they are remitted by the merchant in a settlement batch. If a merchant does not remit batches daily, it is possible for the authorization hold to fall off your account before the actual transaction posts, creating an overstated balance.
Drew has a checking account balance of $250. He uses his debit card to make a $40 purchase at a florist that uses batch processing. A $40 authorization hold is placed on his account, reducing Drew’s available balance to $210. The florist does not process the batch in a timely manner, so the authorization hold expires before the transaction processes, causing $40 to temporarily reappear in Drew’s available balance. If Drew relies on a balance inquiry instead of keeping a register, he may think he has $250 to spend instead of $210.
Some merchants, such as a gas station or restaurant, do not know the final amount of the purchase when the authorization is made. These merchants may authorize either a standard or an estimated amount, which could be different from the actual purchase amount. If your account balance is not sufficient to cover the estimated authorization, it could cause a problem.
When a card is swiped at a pay at the pump gas station, authorization is provided before the gas is pumped. Gas merchants request a preauthorization for a standard amount, typically $1, but sometimes up to $75. When the transaction is processed, the actual amount posts, and the authorization hold is removed.
Julia stops for gasoline on her way to school. She swipes her debit card at the pump, which places a $1 authorization hold on her account. Because she is running late, Julia forgets to record the gas purchase of $25 in her register. Later that day, she checks her balance at an ATM, which indicates a balance of $99. If Julia relies on this balance and makes an $80 cash withdrawal, her account would be overdrawn the next day. Why? Her balance had been reduced by the $1 authorization hold, not the actual purchase amount of $25. Her actual balance is $100 – 25 = $75.
Some restaurants add an estimated tip amount to the authorization. If your account balance is not sufficient to cover the estimated authorization, it could result in a denied transaction or an overdraft.
Jared’s account balance is $37.33. His restaurant bill without tip is $35, and he plans to leave a tip in cash. The restaurant’s card reader automatically adds a 15 percent tip to each authorization amount, so the swiped transaction amount is raised to $42.92. If Jared has elected to receive overdraft privilege on his account, the transaction will be approved, but it could create an overdraft on his account. If Jared has NOT elected to receive overdraft privilege, the transaction will be denied, and the restaurant would ask for an alternate form of payment.
Hotels may authorize an estimated total amount of your stay at the time of check-in. This total may include the room fee, plus a fixed percentage to cover room service charges and taxes. To avoid potential account problems, make sure the amount of your stay is in your account at the time of check-in, even though your actual charge will not occur until check-out. To avoid affecting your bank account, consider using a credit card when checking in to a hotel.
Car rental authorizations work similarly to hotel authorizations. The total amount may be authorized on the date of the rental rather than the date of return.
On Sunday, Simon and Claire check-in to a hotel for a long-awaited vacation. Claire’s paycheck will be direct-deposited to their account on Wednesday, which will more than cover the hotel stay. Simon provides his debit card at the front desk. The hotel authorizes an estimated total of $1,500 for five hotel nights plus incidentals. A $1,500 authorization hold is posted to their account, which has a balance of $2,500.
On Monday, their $1,200 house payment clears the bank, creating an overdraft due to the $1,500 authorization hold. This can be a bit confusing, so let’s look at the transactions in a table format.