Most holders of bank accounts will use an overdraft at one time or another.
What is an Overdraft?
Overdrafts are in essence a short term means of consumer credit for account holders at banks and building societies. When an overdraft is granted, the account holder is given an overdraft limit: this is the amount of money they are allowed to borrow over and above any funds in their account. In other words, the overdraft starts to be used when the balance of the account goes below zero.
Though some lenders can offer customers a free overdraft, most providers will specify some form of overdraft charges. There are a number of types of charge that can be attached to an overdraft: they can include a charge for arranging the overdraft, a monthly or yearly fee for maintenance of the overdraft, charges for raising or lowering the level of the overdraft, and charges for going over the overdraft limit.
In addition, most overdrafts will be subject to interest charges, meaning that debt incurred will accumulate if it is not paid off. The interest for any given overdraft can be obtained by finding the overdraft rate; overdraft rates vary between lenders and even between different accounts at the same lender, so any borrower likely to need an overdraft should be sure to compare these rates when deciding on which account to open.
In general, overdrafts should only be considered for short term lending as they can be expensive to maintain over a long period. Borrowers anticipating the need to lend money long term should consider loans as an option.
Overdrafts arranged in the normal way, by the account holder making an application to their bank or building society which is then accepted, are known as authorised overdrafts. Overdrafts authorised by lenders in this way tend to have lower interest rates than unauthorised overdrafts, and as long as the borrower keeps their account in good order can be a convenient way of obtaining credit.
Sometimes borrowers don’t keep their overdrafts in good order. When the holder of a bank or building society account goes over his or her overdraft limit without permission, this is known as an unauthorised overdraft. Bank customers should do all they can to avoid going into an unauthorised overdraft, as the penalties for doing so are quite stringent: not only are interest rates usually much higher than is the case with authorised overdrafts, but the account holder will also be liable for stiff charges for going over their overdraft limit in this way. With some bank accounts, charges can be imposed daily, though there is usually a limit on how much can be charged in a monthly period, as each lender is required by the financial authorities to lend responsibly. This includes not hitting customers with unnecessary overdraft charges.
Overdrafts for commercial clients are different than those available for individual consumers. Business overdrafts have their own set of charges and fees: for instance, businesses may be charged for depositing and withdrawing cash when in overdraft. Business account holders should fully check what they will be charged for before requesting an overdraft to ensure they are not surprised by charges they do not expect.
Students also get their own specialised type of overdraft. Student overdrafts tend to have better terms for authorised overdrafts compared to other consumers, with interest free periods lasting much longer.