What is Overdraft Interest? (A Canadian Guide)

What is overdraft interest? (other than a pain in the behind). While my Motive Financial Savvy Savings Account is great because it offers an over 4.10% interest, sometimes I forget to transfer over funds from my savings account to my chequing account. When my chequing account balance is too low, and I write a cheque from my chequing account, I get charged a large amount of interest because there are insufficient funds.

Overdraft interest can be a real pain in the butt for Canadians. In this post, I’ll go over everything you need to know about overdraft interest in Canada, including what it is, how overdraft interest works, and how to avoid the painful charges.

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What is Overdraft Interest?

Overdraft interest is the interest charged to you on the amount of money that you borrow from your bank, specifically in the situation when you overdraw your account. When you overdraw your account (for example, you write a cheque for $100 but there’s only $20 in your account), your bank covers the difference and then charges you a fee for “spotting you”. This charge is dependent on the amount of money that they lent you and how long it takes to pay the amount back. The amount charged also can vary depending on your bank.

In addition to the overdraft interest, your Canadian bank or financial institution will also charge you a overdraft fee for not having sufficient funds in your account. For Motive Financial (I have unfortunately lots of experience over drafting with this financial institution) the overdraft fee is $5.

I then got charged annual 18% interest (calculated daily) on the amount I overdrafted. For example, I overdrafted by $1000 and I didn’t realize it until 25 days later, that’s about a $12 charge in addition to the $5 overdraft fee charged by the financial institution.

How Does Overdraft Interest Work in Canada?

What is the overdraft limit charge?

In Canada, the interest rates when you overdraft can be different between bank to bank, but generally, they are higher than other types of loans, such as personal loans or HELOC loans. They are closer in interest amount to credit card interest rates.

The interest rate on some overdrafts is usually a variable rate that is dependent on the Bank of Canada’s prime rate. This means the prime rate from the Bank of Canada increases, the overdraft interest rate will also go up.

For example, with CIBC, the unsecured overdraft interest rate is the CIBC prime rate + 5% per year.

Overdraft interest is calculated based on the amount that you overdrew and the duration of time you owe the money to your financial institution. Banks in Canada usually charge overdraft interest on a daily basis.

This means that the longer you owe the money (or the longer you don’t realize you overdrafted your account), the more interest charges that you will have to pay.

Finally, there is often an overdraft limit. So a maximum dollar amount that you can overdraft on.

How to Avoid Overdraft Interest in Canada

How do you avoid the pesky overdraft interest charges in Canada?

Well, the best way to avoid the charge in the first place is to keep an eye on your account balance, avoid overdrawing your account. I put a sticky post it note on my cheque book now to remind myself to make sure there’s enough funds in my Motive Financial chequing account before I write the cheque.

Here are some other tips to help you dodge overdraft fees and interest:

Set Up Account Alerts

With many Canadian banks (especially the big banks), you can set up account alerts to notify you when your account balance is low. For example, my EQ Bank Savings Plus account does this (actually it notifies me for most transactions in my account in addition to this). This can help set up a reminder to add money into that account to prevent overdraft fees.

Use a Hybrid Chequing Account

If you don’t like having a separate chequing and savings account, you could consider using a hybrid chequing account. The EQ Bank Savings Plus account gives you the interest rate of a savings account but functions like a chequing account, so the chance of over drafting is much less.

It kind of functions like a little overdraft account to prevent you from overdrafting on your chequing account.

Call The Bank And Ask for Forgiveness

Although this doesn’t prevent the charge in the first place, sometimes calling the bank and asking for forgiveness works. Depending on your loyalty and how long you’ve been with the financial institution, they will waive the fees. Unfortunately for Motive Financial they didn’t do this for me, but it doesn’t hurt to call and ask (well it does take up some time being on hold with customer service).

Sometimes, I accidentally overdraft the “minimum balance” needed to avoid a monthly bank fee, but by calling the bank they waive this for me. There is no interest charged in that case but just the monthly bank charge for the month whether it be $16.95 or $29.95.

Link Your Accounts

If you don’t want to use a hybrid account, some banks in Canada give you the option to link your chequing account to a savings account. So in the event you overdraft your chequing account, your savings account will be back up.

Be Wary of Overdraft Protection

You have probably been offered Overdraft Protection before, like Overdraft Protection RBC. Overdraft protection might seem attractive, but it can also take you down the dark path of more fees and overdraft interest. Overdraft protection plans are around $5 monthly with Canadian banks and it will protect you from the overdraft fee, but you will be still charged on the interest of overdrawn balances, and it can be around 21% annually.

Overdraft Interest in Canada Recap

Overdraft interest is expensive for Canadians and can be annoying. Hopefully this post on what is overdraft interest in Canada helps you understand what it is, how it works, and how to avoid it in the future so that you can avoid these unnecessary and expensive fees.

Have you ever had to pay overdraft interest? Were you able to get the bank or financial institution to waive the amount?

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