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Benefits, costs and limits of overdraft protection in Canada
Overdraft protection means you don't pay high NSF fees if you overspend. But overdraft limits and fees still apply.
When money is withdrawn from a bank account and the account balance dips below zero, this is known as an overdraft.
In almost all circumstances, going into overdraft means paying an NSF fee. To avoid expensive costs associated with overdrafts, many banks and financial institutions offer overdraft protection.
What is overdraft protection?
Overdraft protection is a feature of your chequing account, or day-to-day bank account, that allows you to continue spending or paying bills even after you’ve exhausted all available funds.
In most circumstances, overdraft protection helps you avoid expensive non-sufficient fund (NSF) costs. NSF fees are charged when you don’t have enough money in your bank account to cover all your living costs and bill payments.
Without overdraft protection, each NSF fee could cost you $40 or more. With overdraft protection, you avoid the expensive NSF fee, but pay the cost of overdraft protection.
By signing up for overdraft protection you are essentially agreeing to a short-term loan from your bank or financial institution. This short-term loan is triggered any time your account is in overdraft, and the sum you borrow is just enough to cover the shortfall.
For example, if you had $5.00 in your account and you spend $20.00 on a debit card purchase, your account would be overdrawn by $15.00.
Since you’re effectively borrowing money, you’ll usually be charged interest and you may also be charged overdraft fees.
Most chequing accounts, and many online bank accounts or fintech money accounts, come with an overdraft option. The key is to know what protection you are paying for and the overall cost of this coverage.
To help, here’s a breakdown of the standard overdraft protection fees associated with most Canadian bank accounts:
|Fee type||Average cost||What it’s for|
|Overdraft||$5.00 – can be charged per item, day, or month.||When your bank covers the difference for insufficient funds.|
|Non-sufficient funds||$40.00+/item||When your bank declines a transaction or rejects a check due to insufficient funds it will charge (NSF)|
|Overdraft protection||$5.00/month – though this may be included in your monthly account fees||When your bank automatically transfers funds from a linked account to cover a transaction you’ve charged.|
What is an NSF fee?
Your bank charges a non-sufficient fund fee, or NSF fee, when you spend more than you have in your chequing account. Each NSF fee can cost you $40 or more, which can add up if you forget about automatic bill payments or have trouble keeping track of your balance.
Overdraft protection is less expensive and provides a buffer against accidental overspending. Check out our guide to the best no-fee chequing accounts to find out which accounts include overdraft protection in the monthly fee (subject to credit approval).
How to apply for overdraft protection
Most chequing accounts will ask if you’d like overdraft protection when you initially set up the account. If you didn’t add it as part of your account coverage when you first opened the bank account, not to worry, as most accounts will let you add this protection (if offered) at any time.
In most cases, you can apply for overdraft protection online or from your banking app. When setting up overdraft protection, you’ll be asked what overdraft limit you’d like and you may need to approve a credit check.
The overdraft limit is the total amount your bank will cover, should your account go into overdraft. In Canada, typical amounts are between $100 and $2,000. Just remember, there’s a cost every time you use your overdraft protection and, in some situations, that cost is tied to the amount of overdraft used.
How are overdraft fees calculated?
Overdraft protection comes with 2 types of fees: A service fee and interest. The service fee is a flat fee, often around $5.00, paid monthly or every time you use overdraft protection (you may get to choose, or your bank may only offer 1 of these options). This fee may be waived with some chequing accounts.
Regardless of whether the flat fee is waived, you’ll pay interest on your overdraft balance. Interest rates vary but generally fall between 19% and 22%.
Pros and cons of a bank account with an overdraft
- Some overdrafts are interest-free up to a set limit.
- If used sensibly, overdraft protection can help improve your credit score.
- Overdrafts are flexible, allowing you to borrow what you need when.
- Overdrafts are quick to arrange.
- There is no set repayment term.
- Interest rates can be high.
- If you regularly exceed your overdraft limit, this can negatively impact your credit score.
- Your overdraft is not guaranteed and can be cancelled at any point.
- Borrowing limits are usually lower compared to other forms of credit such as credit cards and loans.
Who benefits from overdraft protection?
A buffer against accidental overspending, overdraft protection is good for those who are learning to manage their money. It’s useful when teaching kids how to spend responsibly. Teens who are just beginning to take on adult responsibilities like budgeting and paying bills can benefit from having a safety net for accidentally overlooked expenses. If you’re a student on a tight budget, avoiding expensive NSF fees is a big plus.
Overdraft protection is also good if you manage a complex schedule of recurring bills and automatic payments. It can be tough to keep track of what comes out of your account and when payments are due. Having a buffer can reduce the stress of paying costly NSF fees.
Tips for avoiding going into overdraft
The best way to avoid going into overdraft is to keep your finances healthy. To help keep your finances in good shape you should:
- Check your balance. Overdraft fees can add up quickly, so stay up-to-date with your finances by checking your balance, setting up push notifications on your banking app when your balance falls below a certain threshold. You could also use an app like Mint to get notifications when your bills are due so you can make sure you have enough money in your account to cover them.
- Use ATMs with caution. Certain machines will let you withdraw money you don’t have, potentially leading to hefty overdraft fees.
- Be aware of pending balances. Account balances displayed on ATMs and online may not always be correct. Recent purchases can take time to show up, so factor in any recent pending purchases when deciding what you can spend.
- Know how much you can handle. Steer away from spending too much by choosing the lowest possible overdraft protection limit.
Is a chequing account with overdraft protection a good idea?
In theory, there’s no harm in at least applying for overdraft protection and having it as a backup on your bank account. When used sparingly, overdraft protection can be much cheaper than NSF fees. However, if you do use overdraft protection, be aware of the catches:
- It can be an expensive form of borrowing. Depending on the interest rate your bank offers, the interest can add up.
- Be especially careful if you have more than one chequing account. If you spread your money between different accounts, you may accidentally end up using your overdraft even if you don’t actually need it.
Ultimately, it all comes down to how much your bank charges. There are chequing accounts with relatively low-cost overdraft protection. For instance:
Some tips if you’ve already gone into overdraft
Here are some tips to help you avoid fees and make the best use of your overdraft:
- Figure out how much you need to pay back. Collate all the fees that apply to you and figure out if you need to pay off the loan on demand.
- The faster you pay off your debt, the better position you’ll be in. Discover if there’s a time limit. You may have to pay your overdraft by a specified time so it’s wise to repay the amount you owe as fast as you can to lower the level of interest you might incur. Once you’ve paid back the money, it’s a good idea to cancel the overdraft so this doesn’t happen again.
- Judge your spending habits. Do you spend more than you earn on a regular basis? If you’ve had to deal with several overdrafts, it might be time to sit down and write up a new budget. If you need a few pointers, check out our helpful guide on how to make a budget.
Can you switch chequing accounts if you have overdraft protection?
Yes, you can. Having overdraft protection doesn’t prevent you from opening and closing any bank account — as long as there is no money owing on the overdraft.
How to compare bank accounts with overdrafts
If you’re looking for a bank account with cost-effective overdraft protection, it’s important to consider how often you’re likely to use your overdraft and how much you’ll be charged for doing so.
Some bank accounts offer interest-free overdraft protection, while others do not charge a flat-fee, but do charge interest on any borrowed amount. The key is to know how you will use the overdraft protection and to calculate what it would cost for each account you are interested in opening.
To find the best bank account for your needs, check out Finder’s guide on the best chequing accounts by feature.
If cutting costs is your main goal, consider narrowing your search to chequing accounts with no or low fees such as:
Alternatives to overdrafts
Overdrafts are definitely not your only option when it comes to borrowing:
- Credit cards. If you often end up overspending one month only to make up for it the following one, getting a credit card can be much better than dipping into your overdraft. As long as you clear your balance in full every month, you won’t be charged any interest. Learn more about transferring money from a credit card to a bank account.
- Personal loans. If you already know you’re going to have to borrow money in the near future, or are looking to fund a medium-to-long-term project, there’s really no point in relying on your overdraft. A personal loan will probably be more suitable for your needs.
Finally, if you find yourself overusing your overdraft, maybe the time has come to do a bit of budgeting and reorganize your finances. If it sounds like a daunting task, why not try a budgeting app?
An overdraft can be a handy addition to your bank account and can offer a valuable safety net in the event an unexpected payment pushes you into the red, for example. Applying for an overdraft is usually straightforward and there are a few low cost options available.
However, it’s important to stay within your overdraft limit and try to pay back the amount borrowed as soon as possible. Otherwise, the more you rely on your overdraft, the harder it will become to get out of it.
Frequently asked questions
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