What is Bank Overdraft? Understanding the Basics

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Bank overdraft loan is a kind of financial instrument that is offered to certain customers by various banks in the form of an extended credit facility, which actually comes into effect once the balance of the account reaches zero.

In other words, a bank overdraft loan is an unsecured form of credit that is primarily utilized for covering short term capital needs and requirements.

Banks provide a credit limit to the bank customers based on their relationship with the bank. The bank levies a separate rate of interest as well as charges towards non-maintenance of account. The rate of interest for the overdraft loan facility may vary from one bank to another.

Features of Bank Overdraft

Following are the features of bank overdraft facility such as:

1. Banks provide overdraft facilities on a predetermined limit which typically differs from one borrower to borrower.
2. In an overdraft account the withdrawal or deposit of an amount can be usually done anytime up to the specified limit.
3. The bank charges a rate of interest on the overdraft amount which is easily calculated regularly on a daily basis. It is also billed monthly to the borrower’s account. There is an increased elevation in interest rate if the borrower defaults in paying the overall amount.
4. Banks generally do not charge prepayment penalty on the borrowers in the event of loan repayment prior to the tenure. This is such a kind of a feature that is gradually different from other kinds of overdraft loans.
5. The EMI system is not gradually applicable in bank overdraft accounts. Borrowers can potentially repay the total amount by paying off various numerous values each time.
6. There can be joint borrowers of an overdraft loan as well as both the applicants are equally responsible for repaying the borrowed amount.

Types of Bank Overdrafts

There are two kinds of bank overdraft accounts that can be understood as the following:

1. Authorized Bank Overdraft: In such an overdraft account there is probable arrangement easily made in advance between the account holder as well as the bank. Including both the parties usually mutually agree on a certain limit which can be utilized for all the payments as well as a daily, monthly or yearly service fee that can potentially vary from one bank to another.
2. Unauthorized Bank Overdraft: This kind of overdraft generally occurs when the bank account holder has generally spent more than his actual available balance without any prior authorisation or related such an arrangement with the bank or if there was an arrangement done prior however the limit of overdraft is potentially exceeded.

Advantages of Bank Overdraft

Some of the benefits of bank overdraft are as followed:

1. Usually assists to manage the availability of capital for a business or an individual.
2. Assists in fulfilling urgent capital needs and requirements.
3. Rate of interest requires to be paid only on the amount that is used and not the overall limit.
4. There is a substantially smaller amount of paperwork typically involved in availing the bank overdraft.
5. There is no need for collateral.

Disadvantages of Bank Overdraft

Following are some of the cons of the bank overdraft:

1. Increased rate of Interest is charged for the loan facility availed.
2. It is provided only to the various bank account holders.
3. The limit provided depends upon the financial position of the individual or business.
4. The rate of interest is not fixed as well as the changes frequently.
5. Is not an idiosyncratic option for a period of long term financing.

Do you need an overdraft?

Using the overdraft too much

If a person finds themselves dipping into the overdraft very frequently, A person might want to utilize such a Budget Planner to overtake control of the capital. 

Overdrafts can be pretty useful for certain people. They can assist to avoid fees for bounced or any other returned payments. These also happen when a person tries to make a payment however the account doesn’t have sufficient capital in it.

However, an overdraft loan should primarily only be utilized for any emergencies or as a short-term option.

The Financial Conduct Authority, popularly abbreviated as (FCA) found that numerous people underestimate how much they generally utilize their overdrafts. If a person is using the overdraft more than one thing, it might be costing way more than they realize.

If a person utilizes the overdraft a lot, read the mentioned tips below on how to avoid doing this. They might assist to save capital. If a person finds they are constantly in overdraft as well as don’t have the capital to pay it down quickly, it might be more affordable to borrow using a personal loan or 0% credit card.