Should You Take Out a Line of Credit to Cover Business Overdraft Fees?

Should You Take Out a Line of Credit to Cover Business Overdraft Fees?

Have you ever had a surprise expense withdraw from your business checking account, catching you off guard and overdrafting your account? Now you’re dealing with a negative balance, and depending on your business bank’s policies you could be chalking up some hefty overdraft fees. No business owner wants to be in the red or pay avoidable fees — but when it happens, it’s important to have a plan. Setting up a line of credit to cover your businesses overdraft fees is one option.

What Is a Business Overdraft Line of Credit?

An overdraft line of credit is essentially a loan tied to your business checking account, which covers transactions that would ordinarily bounce because they exceed your account balance. Interest is only charged once you borrow money; when you pay back the borrowed funds, your available credit line is replenished. Overdraft lines of credit are usually less expensive than traditional overdraft protection programs, which can charge about $35 for every single rejected transaction that tries to go through your account.

Let’s take a look at an example of how your overdraft line of credit would work. If you have $100 in your business checking account and need to pay $250 for new invoicing software, you complete the transaction but are $150 short. Your payment to the software company wouldn’t get rejected — instead, it will activate your line of credit (for a predetermined amount of $500) to cover the payment. Interest would begin to accrue once you’ve started borrowing until you pay off the complete line of credit amount. If your interest rate was 3.5 percent per day and you took seven days to pay the balance, you’d be looking at a hefty fee. However, once you pay off the balance, the line of credit is reinstated and can be used fully if you overdraft again.

The Overdraft Line of Credit Controversy

Although an overdraft line of credit is less expensive than a traditional overdraft protection program, it lends itself to overspending habits. It can be a slippery slope to rely on any form of overdraft protection: you’ll always pay more in fees than you need to, and you’ll be stuck failing to implement better cash flow management. And that isn’t the only pitfall to taking out a line of credit to cover business overdraft fees:

  • While there isn’t a specific limit, banks will flag your account if you use your overdraft line of credit often. Some banks may even close your account if this service is overused. Some banks will offer lines of credit for up to $10,000, but most banks are known to extend a line of credit for a small amount, such as $500 to $1,000.
  • Even though overdraft lines of credit are less expensive than overdraft protection, they aren’t without their own fees. Your bank will have you pay interest on money you borrow, even if it’s just for a day or two. The interest should be low, but you might also have to pay a fee every time you use the overdraft line of credit — and the interest accrues daily. Some banks also charge an annual fee to keep the service active on your account.

Overdraft Protection Options

An overdraft line of credit is just one option for overdraft protection. There are other choices, too:

  • Opt-in for overdraft protection. Banks are no longer able to opt you into overdraft protection automatically; you have to specifically choose it yourself. If you choose to opt-in, you can continue to use your debit card in exchange for a fee. However, it will mitigate the inconvenience of a rejected transaction.
  • Opt-out for overdraft protection. Depending on your business needs and whether you want to pay additional fees, opting out of overdraft protection could be right for you. If you don’t want to pay any additional fees, you can choose to opt-out of overdraft protection and let the bank simply reject any attempted transactions. You can then pay an alternate way or forgo that expense.
  • Transfer from another account. Some banks allow you to link your savings account with your checking account. In the event that you overdraft, your bank will transfer available funds from your savings into your checking. Depending on the bank, there may be a fee for this service — but it will prevent you from using funds you don’t actually have. You can also set it up so your savings account gets used before you borrow from a line of credit. For example, once your checking account hits a balance of $100, your savings account will transfer money over.

How to Better Manage Your Money

Sometimes overdrafting your account comes as a complete surprise. Aside from any type of overdraft protection or management, there are many ways to better manage your money to avoid any of those surprises and fees.

  1. Set up alerts. Many banks have mobile apps that allow you quick and easy access to view the status of your accounts, and let you set up an alert when your account balance is low (you can preset the trigger amount).
  2. Manage your business budget. Utilize financial software or spreadsheet templates to manage your revenue, costs, profits and cash flow. Staying on top of your budget will allow you to avoid overdrafting, set business goals and have a constant understanding of where your business stands financially.

Taking out a line of credit is only one option you have when overdrafting your business account. It will give you a safety net of overdraft protection on your checking account, but it may result in higher fees depending on how quickly you can pay off the line of credit. It’s important to research all of your options and what will fit best for your business. However, organizing your finances is key to avoiding frequent overdraft fees and staying knowledgeable about the overall financial health of your business.

How have you tackled overdraft fees? Let us know on Twitter at @Revenued_com.

Chris Keller is a veteran in business finance. Prior to starting and managing his own business, he managed product lines at two Fortune 500 companies focusing on their Profit & Loss statements.
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