An overdraft is a convenient way to borrow money for a short period of time to pay unforeseen expenses. However, before you use your bank overdraft, make sure you understand everything about it. This includes how to apply and get an overdraft, as well as how it gets paid back. Knowing the ins and outs of an overdraft can help you pay less interest, if not none at all.
What Is an Overdraft?
When there isn’t enough money in an account to fund a transaction or withdrawal, but the bank approves it regardless, it’s called an overdraft. In essence, it’s a financial institution’s extension of credit given when a customer’s account balance reaches zero. The overdraft allows the account holder to withdraw money even if there are no funds in the account or insufficient cash to pay the withdrawal amount.
An overdraft is a loan from a bank that allows consumers to borrow a specific amount of money. There is interest on the loan, as well as a fee for each overdraft. An overdraft fee at certain institutions can be as high as $35.
An overdraft account allows a bank to cover payments made by a customer that would otherwise be rejected or, in the case of physical checks, bounce and be returned unpaid.
The borrower pays interest on the outstanding balance of an overdraft loan, just like any other loan. The interest rate on the loan is frequently lower than the interest rate on credit cards, making an overdraft a preferable short-term option in an emergency. In many circumstances, there are additional fees for employing overdraft protection, such as insufficient funds fees per check or withdrawal, which lower the amount available to cover your checks.
Points to Consider
Your bank may choose to cover your overdraft using its own money. Linking the overdraft to a credit card is another possibility. If the bank covers your overdraft with its own funds, it usually has no effect on your credit score. When you use a credit card for overdraft protection, you risk increasing your debt to the point where it affects your credit score. Overdrafts on your bank accounts, on the other hand, will not be a concern.
If you don’t pay back your overdrafts within a certain time frame, your bank may transfer your account over to a collection agency. This collection activity will have an impact on your credit score and will be reported to the three major credit reporting agencies: Equifax, Experian, and TransUnion. Whether or not an overdraft on a checking account is reported to the agencies depends on how the account is reported to the agencies.
Overdraft Protection
Some, but not all, banks will automatically cover overdrafts as a favor to their customers (while charging fees, of course.) Overdraft protection adds another option to the customer’s arsenal for avoiding humiliating deficiencies that reflect negatively on your ability to pay.
It usually works by connecting your checking account to a savings account, another checking account, or a credit line. If there is a shortage, this source is used to make up the difference, ensuring that no checks are returned or transactions/transfers are denied. It also prevents a charge for insufficient funds (NSF).
The amount of overdraft protection varies depending on the account and the bank. Frequently, the buyer must expressly request it. Overdraft protection has a number of advantages and disadvantages, but it’s important to remember that banks aren’t giving the service out of the goodness of their hearts. Usually, they charge a price for it.
As a result, consumers should only use overdraft protection when absolutely necessary. The banking institution may remove the overdraft protection from the account if it is utilized extensively.
What is a Bank Overdraft?
A bank overdraft is a line of credit that covers your transactions in the event that your bank account balance falls below zero.
The Advantages of Bank Overdrafts
A transaction account overdraft allows you to access additional cash up to an allowed overdraft limit, avoiding overdraft and dishonor costs.
Only the amount overdrawn is subject to interest (when fees and charges are paid on time). Depending on the type of overdraft you pick, you may be charged a monthly loan account fee.
Withdrawals from your overdrafts can be made in a variety of ways, including ATM, branch, Debit Mastercard, BPAY®, Online, Mobile, Telephone, and EFTPOS.
Overdrafts don’t have a defined payback date, so you can pay them off whenever you wish, such as when your income is credited to your account.
To minimize overspending, you should carefully evaluate the overdraft limit you request for.
There are credit requirements, terms, and conditions, as well as fees and penalties.
When is an overdraft from a bank not the best option?
Overdrafts can help you cover short-term cash flow problems. They are not, however, suited for debt consolidation.
What Is an Overdraft Fee?
An overdraft is a bank loan that allows a consumer to pay bills and other expenditures when their account balance falls below zero. In the event of an unforeseen charge or insufficient account balance, the bank gives a loan to the client for a fee. A one-time funding fee and interest on the outstanding balance are usually charged on these accounts.
How does an Overdraft Work?
If a client’s checking account falls into a negative balance due to overdraft protection, they will be able to obtain a predefined loan granted by the bank and will be charged a fee. Overdraft protection is frequently utilized to avoid a check from bouncing and the associated embarrassment. It may also prevent a non-sufficient fund fee, but in many circumstances, both types of fees will cost around the same amount.
Before you may use overdrafts, you must first request an overdraft on your current account from your bank. If the bank believes you will be able to repay an overdraft, it may offer you the option of a short-term or long-term loan.
The amount of the overdraft will be restricted. The amount of an overdraft you receive, if any, is usually determined by how effectively you have previously handled your account. The bank, for example, will look into whether you pay your bills on time and pay off your credit card debt each month. If you have a poor credit history, getting overdrafts may be challenging.
What Are the Advantages and Disadvantages of Overdrafts?
Overdraft benefits include providing coverage when an account has insufficient cash suddenly, as well as avoiding embarrassment and “returned check” costs from merchants or creditors. However, it’s critical to consider the costs. Overdraft protection is frequently accompanied by a hefty fee and interest, which, if not paid off in a timely manner, can add to the account holder’s financial burden. Customers who had overdraft protection, according to the Consumer Financial Protection Bureau, sometimes paid more in fees than those who did not.
Arranged Overdrafts vs. Unarranged Overdrafts
Your bank will agree to an overdraft limit with you if you have arranged overdrafts. An interest-free buffer is usually included with pre-arranged overdrafts. This is the maximum amount you can owe before incurring interest.
When you don’t have an overdraft agreement with your bank yet spend more than the amount in your current account, you have an unarranged overdraft. You will be in an unarranged overdraft if you spend more than your arranged overdraft limit.
Overdraft Interest
If you use a bank overdraft, you may have to pay interest. Before you spend money, always check the interest rate to make sure you can comfortably afford to pay it back. On their websites, banks should have an overdraft cost calculator. You can use this to estimate how much overdrafts will cost you. Interest is usually not charged on student overdrafts.
How does an Overdraft get Paid Back?
If you use your overdraft to borrow money, the faster you repay it, the less interest you’ll pay. You can repay your overdraft by transferring funds from your checking account to your current account. Even if you can’t pay it off all at once, moving what you can afford will lower the amount of interest you pay because interest is computed based on your daily balance.
The bank will set a deadline for paying off the overdraft. When money is deposited into your account, the overdraft is repaid to the bank. If you do not repay your overdraft within the agreed-upon time frame, it may negatively impact your credit history. Thus, making it more difficult to get loans or overdrafts in the future.
Canceling your Overdrafts Limit
If you agree to an arranged overdraft and later change your mind, you have 14 days from the date the overdraft was granted or the day you received a copy of your overdraft agreement, to cancel it (whichever is later).
You can also request that your limit be reduced or that your scheduled overdraft limit be removed at any time. Any overdraft, as well as any interest accrued during the time you had it, must be repaid.
Here are a few things to consider if you need to cut your spending to pay off your overdrafts:
- Make a budget to track where your money goes.
- Divide your expenditure into ‘needs’ and ‘wants,’ then concentrate on reducing your ‘wants.’
- Keep a tight eye on your expenditures to ensure that you stay on track with your budget.
- Find out how to get out of an overdraft.
Do Overdrafts have an Impact on your Credit Score?
Credit Reference Agencies (CRAs) collect and store information about your credit history in a secure manner, including:
- when a bank account was established
- If you have an overdraft limit in place and how much it is
- What you do with your overdraft
If you properly manage your account and overdraft, you can improve your credit score. If you go into an unplanned overdraft, though, it might harm your credit score and your ability to obtain credit in the future.
What happens if your overdraft doesn’t get paid back on time?
Many banks have the ability to withdraw your overdrafts and demand repayment at any time. So, don’t get reliant on it. Using your overdrafts on a regular basis may result in large interest costs. Thus, making it more difficult to repay the amount.
Your bank may be able to assist you if you are unable to repay any loans you have taken out.
How to Apply for an Overdraft
To apply for an overdraft, contact your bank or building society. You can apply online, over the phone, or by filling out a paper application. All overdrafts are subject to application, financial conditions, and borrowing history, including any interest-free sums. To apply, you must be at least 18 years old and reside in the United Kingdom. Overdrafts must be repaid on demand. Because of various restrictions, not all customers can apply for arranged overdrafts in online banking.
Conclusion
We’ve all been there when the bills are due and payday hasn’t arrived yet. When you need to proactively handle these regular cash flow scenarios, overdrafts come in handy.
When your balance falls below zero and you don’t have an overdraft facility in place, banks charge you an “overdrawn fee.”
Frequently Asked Questions
Is it good to have an overdraft?
As long as you don’t go over your overdraft limit or have payments refused, a scheduled overdraft is unlikely to have a significant impact on your credit score. Your credit rating will be harmed if you are consistently over your overdraft limit. This is because it indicates to lenders that you may be experiencing financial difficulties.
What is overdraft limit?
Overdraft limit is a limit on the amount of money that can be withdrawn in excess of a bank or building society account’s credit balance.
Is an overdraft better than a loan?
Overdrafts are appropriate for short-term operating needs, whereas loans are better for higher-value purchases over a longer period of time.
