What are Non-Sufficient Funds?
Non-sufficient funds is the term used when the holder of a checking account is overdrawn — meaning there is not enough money in the account to pay the check written against it. The bank returns the “bounced” check to the accountholder and charges a returned-check charge, or a non-sufficient funds (NSF) fee.
A returned check stamped with NSF means the check has not been honored by the bank because the accountholder doesn’t have enough funds in the account or the account has been closed. Fees for non-sufficient funds are high, usually around $35 per check. This is why it is good to have a second account or an overdraft line as a backup in case the primary account runs low on funds.
The recipient of the bad check also may incur bank charges. If the payee has a second account with the bank, his bank will be able to fund the check. If there’s not a second account, however, the bank will charge the payee for trying to cash a check with non-sufficient funds. The issuer’s bank will charge an NSF fee to the writer of the check.
How Non-Sufficient Funds Fees Work
Banks often charge NSF fees when a presented check is returned due to a lack of funds to cover it. A similar fee may be assessed when honoring payments from accounts that have insufficient balances. The latter scenario describes an account overdraft (OD), which is often confused or used interchangeably with non-sufficient funds.
The fees many banks charge for NSF checks are a bone of contention between consumers and banks. Consumer advocates allege that as fees are usually a fixed amount, customers are, in effect, paying extraordinarily high-interest rates for relatively small deficits in their accounts.
NSF Fees average $34 each, according to 2022 data from the Consumer Financial Protection Bureau.
Consequences of Non-Sufficient Funds
Due to insufficient funds, if a check is bounced, both the defaulter and the payee are penalized by their respective banks. If the bounced check is against the repayment of any loan, the defaulter may need to bear additional late payment charges. Penalty charges vary and are different for different account types.
Bad Impact on Credit Score
A bounced check can hugely impact a person’s creditworthiness and hamper his/her financial credit history. Financial institutions may feel insecure about lending to someone with a bad credit score and failure to pay his/her due debts previously.
Therefore, it is always advisable to save enough funds before applying for a loan. In doing so, lending institutions and banks will be secure with your financial credibility and will not hesitate to lend money.
If a check bounces and the defaulter is unable to pay within the stipulated period, not only does his/her credit score plunges, but he/she can also be prosecuted under existing criminal law, as well as under Section 138 of the Negotiable Instruments Act.
Under Section 138, a dishonored check is a criminal offense, and the aggrieved party can send a legal notice to the defaulter. If found guilty, the defaulter can be charged with imprisonment for up to two years and/or with a monetary penalty, which can be as high as twice the check amount.
Under Sec 417 and 420, if a case of cheatings been proven, a non-bailable warrant can be issued. If more than one check is bounced, the payee can file separate suits against each dishonored check.
Banks issue cautionary advice to the defaulter in the event of dishonor of a check. In the case of repeated defaults, they can close the account and stop the check facility. When a check on a loan is dishonored, the banks can issue a legal notice or deduct money from the defaulter’s account.
Checks may be dishonored due to a signature mismatch, overwriting, or a stale date. Legal remedies can be taken only if a clear case of cheating is proven.
Criticism of NSF Fees
Complaints about NSF fees are nothing new, as the 2010 bank reform legislation suggests. There have been numerous lawsuits over the years; the 2010s, in particular, have seen an increase in class action lawsuits challenging the manner in which financial institutions charge overdraft and non-sufficient funds fees.
These lawsuits don’t try to deem NSFs illegal; rather, they allege breach of contract and unjust enrichment in the way they’re applied. Different specific practices that have been cited include:
- Reordering transactions: Financial institutions processing debits to consumer accounts in a way to maximize overdraft fees—deducting the largest first, rather than in chronological order. This strategy triggers negative balances and more frequent overdraft fees.
In 2011, Bank of America settled a two-year-old class action for $410 million for reordering customer transactions and charging overdraft fees in this way. TD Bank paid over $62 million in a class action settlement for the same thing in 2010.
- Authorize positive, settle negative: Financial institutions authorizing transactions at a time when customers had sufficient funds in their accounts to cover them, or promising to set aside funds—and then charging fees because the accounts had insufficient funds later, at the actual time of posting and settlement.
In 2020, the Bank of Hawaii set up a settlement fund of $8 million to repay clients who had been charged in this way from 2010 to 2017; it also agreed to forgive overdraft fees that remained unpaid.
- Single transaction, multiple fees: Financial institutions assess more than one NSF fee on a single item or transaction because the payment request is automatically re-submitted repeatedly (by the creditor, not necessarily with the bank customer’s knowledge). In 2020, the Navy Federal Credit Union settled such a case for $16 million, without conceding any wrongdoing or liability.
How to Avoid a Non-Sufficient Funds Situation
- Reconcile the checking account frequently and keep track of balances
By keeping track of the balance and frequently reviewing transactions, you will know how much you can spend and, accordingly, can account for any unexpected changes.
2. Set up alerts with the bank
Banks may still allow certain payments to go through even if a customer is short of cash (and charge insufficient funds fees). For example, insurance premiums will most likely be paid even if the bank’s been asked to decline such transactions.
In such situations, you can consider setting up alerts or texts with the bank so that they can be notified before these transactions take place, giving them enough time to cancel the payment.
3. Implement an overdraft agreement with the bank
Consider opting in for the overdraft protection program. When you opt in for the overdraft facility, the bank executes every transaction it is authorized to, regardless of the approved limit.
In turn, the bank charges an OD fee. To avoid hefty overdraft fees, consider signing up for an overdraft line of credit as it is cheaper than per-item overdraft fees.
Non-sufficient funds example
Jimmy wrote a check for $2,000 to a roofing contractor, not realizing he had only $1,800 in his account. Jimmy’s bank returned the check to him stamped with “NSF” for non-sufficient funds and deducted $38 from his account for the NSF penalty fee. Jimmy went immediately to his bank to make a deposit that would more than cover what he owed the roofing contractor and the NSF fee. Jimmy wrote another check to the roofing contractor, which cleared without a problem.
To avoid getting hit with another NSF fee, Jimmy signed up for overdraft protection. He had a small savings account at the bank and gave the bank permission to tap it to cover checks if there was not enough money in his checking account.