Define Debit Interest

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On the face of it, the term "debit interest" translates in a fairly straightforward manner: when your bank account is in the red, interest is applied to the amount of money you owe the bank for a negative balance in an account. This is opposed to the sort of interest you get in savings or some interest-bearing checking accounts, where the bank owes you interest on the money you deposit. This is known as credit interest, which applies to the amount of money the bank owes you for a positive balance. With debit interest, the bank applies an interest rate to the debit amount to offset the cost and risk of loaning you that amount, given an apparent non-ability to pay for other costs.

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More About Debit Interest

In effect, debit interest is an aspect of the overdraft system, which the team at Bankrate describes as your bank covering the cost of a transaction when the amount in your account is insufficient. When you've drawn more money from your account than is in it, you have "overdrawn" or "overdrafted" your account.

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To ensure that you don't face the inconvenience and embarrassment of a rejected transaction, your bank covers the amount as a short-term loan. The bank does this assuming that you simply made a mistake in transferring funds or miscalculated the timing of deposits. This is not done for free, nor without risk to either the bank or the account holder.

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In most situations like this, the bank will charge a flat account maintenance fee for each transaction that requires an overdraft action, and will then apply a compounding interest rate to the total amount you have overdrafted. The maintenance fee is called an "overdraft fee" while the interest rate is called "debit interest." If the account remains overdrawn after a previously agreed upon number of days, additional fees may be applied.

Different Types of Bank Accounts

Not all bank accounts apply overdraft fees, nor even allow them. You should be able to personalize your account to allow or disallow overdrafts, arrange overdraft protection or even arrange a pre-authorized overdraft limit. The best checking accounts often have this sort of protection for customers.

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Writers from Consumer Reports explain that accounts that prevent overdrafts effectively act as a kind of prepaid gift card, in that they simply will not authorize a transaction for which the funds are not available. This has the benefit of preventing the creation of debt as they literally will not allow you to spend more than you have in your account. However, it can also interfere with an unconventional incoming/outgoing finance cycle, common in many service or commission-based industries, in which you accept short-term loans to pay off bills and utilities while waiting for your incoming deposits to clear.

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Arranged Overdraft and Overdraft Protection

Nerdwallet writers lay out the concept of arranged overdraft, as opposed to automatic overdraft or overdraft protection. An arranged overdraft is when you agree to an overdraft limit and debit interest rate with your bank, effectively agreeing to the terms of a short-term loan which is automatically applied and approved when the amount in your checking account cannot cover the amount you are attempting to pay.

Overdraft protection links a checking account and savings account within the same bank, such that instead of taking out a loan from the bank due to insufficient funds in the checking account, the bank withdraws enough money from the savings account to complete a transaction. There is sometimes a fee for this service

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Debit Interest vs. Overdraft Fee

Debit interest is the interest rate, agreed upon when opening an account and adjusted over time, applied to the amount of funds loaned to a customer when their checking account has insufficient funds. The interest can be applied daily, often compounding with the principal amount, or regularly on set intervals of days.

An overdraft fee is a fixed dollar amount (averaging roughly $33) charged to an account every time it's overdrafted. This means that if an account has $20 in it and the account owner attempts three transactions of $30, $50 and $75 dollars, they will incur three separate overdraft fees of $33 each. This totals $99 dollars, entirely separate from the overdrafted amount of $155 plus debit interest.

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These overdraft fees and debit interest fees can pile up, so it's important to understand the arrangement with your account and your bank. Many banks will allow you to adjust account options to deny transactions or take them from savings. Depending on your financial situation, these can be powerful actions for your financial future.

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