overdraft

What It Is

An overdraft, also called non-sufficient funds (NSF), occurs when a bank customer writes a check that is presented on an account that doesn’t exist or that has insufficient funds to cover the amount of the check.

How It Works

Let’s assume John Doe has $1,000 in his checking account today. He goes to the mall and writes a check for $1,250 at a furniture store. Because there are insufficient funds to cover the amount of the check, John is going to overdraft his account.

When the furniture retailer attempts to deposit the check, the furniture retailer’s bank (Bank ABC) will present the check to John Doe’s bank for payment. John Doe’s bank will then either pay the check (which might occur if John Doe has overdraft protection at his bank) or "bounce" the check by returning it to Bank ABC without payment. Often, banks stamp the check itself with a large "NSF" stamp (which stands for “nonsufficient funds”). Typically, Bank ABC will charge the furniture retailer a fee for presenting a bad check, and John Doe’s bank will charge John for the overdraft. The furniture store will also likely charge John Doe a fee for the overdraft.

Why It Matters

In most states, writing a bad check is at least a misdemeanor, with the consequences growing depending on the state, the amount involved and whether the transaction crosses state lines. Most overdrafts are simply oversights by consumers, so even if the police are not involved, the fees for bouncing checks can run in the hundreds or even thousands of dollars if the check writer is particularly disorganized. For this reason, it’s important to have an overdraft line or a second account from which a bank may draw when the funds in the check writer’s primary account are insufficient.

Source: Investing Answers