Create Your Own Overdraft Protection

There it is, that dreaded little envelope in the mail from your bank that you know is too small to be your monthly statement. It's actually a note informing you of an overdraft fee being charged to your account which is nowadays usually upwards of $35.

You could always apply for overdraft protection from your bank in which they'll happily cover the overages as long as you pay interest. Maybe you simply want to become more disciplined with your money and also avoid paying interest. Or maybe you don't have good enough credit to apply for overdraft protection. Whatever your reason, there is a simple way to avoid overdraft fees or interest payments and it's the old standby our grandparents lectured us about—saving.

This isn't rocket science. Basically, you need to have some cash in your account that you don't touch. This advice isn't for those who already have $500 laying around that they can throw into their account to cover them. It's for those people generally living paycheck to paycheck who definitely can't afford high bank fees. I've been there, done that, and this approach has helped me save face and cash.

We all make mistakes, sometimes costly ones. I've done things like forgotten to record a gas purchase in my check register when using my check card. I've also been self-employed and have had checks from clients bounce which caused my checks for important bills to bounce. When this happens, not only do you look foolish but you could get into serious trouble. You also incur fees for being overdrawn. Here is a simple way to protect yourself against this:

1. Figure out how much extra you'll need in your account to help cover yourself based on your expenses. A baseline of $100 is a good start to at least cover those times you forget to record small purchases.
2. Hold back a small amount in your checking account each paycheck, even if you can only afford $5. Do this by entering POP (short for personal overdraft protection) in your check register just as if it was a company you're paying a bill to and subtract it from your account just like you would a bill.
3. Record the amount you're saving in a separate area. I do this on the last page of my register, but if you're using that for something else, then you can note it in a word document on your computer or write it down and keep it some place safe. Note any changes in the amount plus or minus as you make them.
4. Do this until you reach your baseline amount from #1.

While you will know in the back of your mind that you have that extra $100, it's already been subtracted from your account and not showing up in your check account register. This may force you to think twice before you spend it.

Saving used to be commonplace. Buying on credit is nothing new, but the modern credit card didn't come into existence until the 1950s. I don't want to get too much into a lecture on the importance of savings. But this technique will not work if you can't leave the money you're using for POP alone unless an emergency situation arises (and be honest, you know that new trinket you want isn't an emergency).

If you're disciplined enough to do the POP for a while, you may find yourself becoming more responsible with your finances in general. You'll notice that you don't make your prior mistakes as often. At this time, you might be tempted to do away with your POP. I personally think that a little extra in your account is always a good thing, but it's up to you.

Granted, you won't be earning interest on the money you're saving unless your bank offers checking accounts that bear interest. But you may save yourself hundreds of dollars in fees as one overdraft fee will cause your account to be even more overdrawn thereby causing more of your checks to bounce in which case you incur more fees. This technique can stop that spiraling effect. It may help rebuild your credit and you acquire a little more peace of mind regarding your finances.

Source consulted:

Starbuck Gerson, Emily and Ben Woolsey. The history of credit cards. CreditCards.com, 2009.