How to Break Out of the Overdraft Cycle

Most of us are familiar with overdrafts, whether it’s something we’ve actually done ourselves or not. We write a check for an amount greater than the remaining balance in our checking account and something bad happens.

If you don’t have overdraft protection on your checking account, the bank will refuse to cover your check. This uncashed check is returned to the person or business to which you wrote that check and they’ll usually then come after you for non-payment along with some additional fees. Most businesses will not only charge you late fees on your account, but will also tack on an additional fee for a returned check. Bummer.

To combat this, many banks offer overdraft protection. If you sign up for this, the bank essentially offers you a small amount of credit that kicks in if you ever write a check that exceeds your account balance. They’ll cover your check, but then your account balance is negative and thus the next time you deposit money you’ll have to cover that negative balance first. For this service, banks often charge you a fee for each overdraft and sometimes also charge an interest rate on your negative balance.

In both cases, you wind up in the same situation. When you overdraft, you’re already in a precarious financial state (or else you wouldn’t be overdrafting) and then you’re hit with a bunch of additional fees, making that situation even worse and actually increasing the likelihood of subsequent overdrafts.

Often you wind up in a cycle. You’re unable to cover the bills after covering last month’s overdrafts, so you’re practically forced into overdrafts this month.

That’s a very vicious cycle, and one that’s difficult to climb out of. Many people simply accept it and live on a cycle of overdrafts, which continually drains their finances at a rapid rate and ensures more overdrafts in the future.

If you want to build a better life for yourself, you have to escape this cycle of overdrafts.

But it’s not easy, which is pretty obvious to anyone who’s ever been in this kind of a cycle as well as anyone who spends some time thinking about being in that kind of a cycle.

How exactly can one escape from that cycle?

Here are seven strategies that, when used together, can pull a person out of a cycle of overdrafts. To pull this off, however, you do need to have steady employment that provides an income stream of some kind.

Have a ‘money-free’ month to ‘reset’

The idea of a “money-free weekend” is an idea I’ve talked about since the earliest days of The Simple Dollar. It’s a simple idea – you simply avoid spending money if at all possible for a weekend. You eat food that you have on hand, engage in activities that use as few resources as possible and with as little electricity as possible, and generally try to minimize your expenses in every way from Friday evening to Monday morning.

This is a great idea for kickstarting a financial turnaround, but it’s also an idea that can be expanded greatly to a “money-free month” in order to provide something of a reset to your financial life.

Basically, you just take the idea of a “money-free weekend” and expand it over the full month. Your goal is to minimize your spending in every way possible. If you don’t have to spend money, don’t. Live off of the food you have on hand. Use the cheapest way possible to get to work and back. Use minimal electricity. Buy nothing that isn’t an essential.

The goal of this is to get through a month where you’re not actively overdrafting – or making as few overdrafts as humanly possible.

I’ve used periods like this for many financial goals and I’ve found that the most effective way to make it work is to make it into a game. The goal is to see how low you can possibly go. Can you spend less today than yesterday? Can you spend less this week than last week?

Clean out your closet

Another great strategy that goes hand in hand with a “money-free month” is the good old closet cleaning.

Here’s what you do: You simply pull everything out of your closets and storage spaces and then go through all of it, sorting it into two piles: stuff to keep and stuff to sell.

Ideally, as you’re putting things in the “stuff to keep” pile, you’re finding things that you’re going to want to use in the near future. Maybe you’ve discovered things that got pushed into the back of the closet, things that you can’t wait to actually use. The things in that pile can provide projects and entertainment and clothing for many months.

On the flip side is the “stuff to sell” pile. That stuff should be taken straight to Craigslist and sold to whoever will buy it. The cash generated from those sales can then be directly used to get you out of the overdraft cycle by putting some extra cash into your checking account.

Adopt a budget

One of the biggest reasons that people fall into this cycle is the lack of a budget – more specifically, a lack of understanding of where all of their money is going each month.

The best way to prepare a budget is to simply go through your credit card and bank statements for the last few months, sort all of those transactions into groups – food at home, dining out, utilities, hobbies, entertainment, automobile, rent – and then add up the total for each group. You’ll probably find a surprising amount of money spent on the nonessential categories – eating out, hobbies, entertainment, and so on.

For many people, this can serve as a giant wake-up call as to how much money they’re actually spending on stuff they don’t need. People forget that they’re dumping hundreds a month into cable bills, cell phone bills, internet bills, gadgets, Netflix, and so on, all of which qualifies as “entertainment.”

Those expenses need to be cut hard, at least for a while. You can always sign up for cable or for Netflix in a year or so. You can always add data and other services back onto your cell phone plan.

Cut back on everything nonessential – hard. Keep at it until your financial life is under control and you’re not even in remote danger of overdrafting any more.

Ask for a waiver

Simply go to your bank and ask for a courtesy waiver of some of the most recent overdraft fees. This seems like a simple step, but two things keep people from doing it.

One, there’s a good chance they’ll say “no” anyway. Although that seems like a reason not to do it, it’s actually no different than the situation you’re in right now, so there’s no downside to asking.

Two, they’re “ashamed” to ask the cashier or the customer service rep. If this is why you’re not doing it, swallow your pride. The truth is that the cashier or the customer service rep does not care. They’re not judging you. They’re actually usually just trying to get through a day at work, and if they can easily help with your request, they probably will without skipping a beat. They see or hear hundreds of customers a day. Judging you is not something they’re going to waste their time on.

Ask. The worst that can happen is that they say “no,” which just puts you back to where you already are. In other words, this is a request that’s pure upside for you, so give it a shot.

Sign up for balance alerts

Many banks will send you an automatic text or email if your checking account balance drops below a certain point. Sign up for these. Use these.

The biggest reason many people overdraft isn’t due to not keeping track of the checks they’ve written. The biggest reason most people overdraft is that an automatic payment is withdrawn at an inopportune moment. That’s why balance alerts can be very useful, as they can alert you instantaneously when a withdrawal happens so that you don’t make the mistake of writing a check when you don’t have the cash, or it can give you the chance to rectify an error before the consequences hit you.

Contact your bank and find out whether or not they offer any kind of text or email balance alerts and sign up for whichever is more convenient for you. It’s a way to make your current balance to the forefront of your mind and reduce the number of errors you might make.

Connect your overdrafts to a credit card or savings account

Another approach is to simply forego typical overdraft protections and tie your overdrafts directly to a credit card or a savings account.

This simple move bypasses most of the dangers of overdrafts and overdraft protections. You won’t be hit with a lot of fees or unexpected interest should you overdraft. Instead, what you’ll see is a dip in your savings account balance or an unplanned charge on your credit card, both of which can be much easier to handle than an overdraft.

Again, a quick phone call to your bank can make it clear whether such services are available to you. If your bank can set up this type of overdraft “protection,” then sign up for it as it will keep you out of that overdraft cycle.

Final Thoughts

Getting out of overdraft trouble requires a mix of personal choice, personal sacrifice, and smart use of the services offered by your bank. Using all of these things together in concert can help you escape the overdraft trap altogether and put yourself on a much healthier long term financial path.

Good luck!

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