Overdraft

Detailed Explanation

Overdrafts can be either authorized or unauthorized. Authorized overdrafts, also known as overdraft protection, are pre-agreed limits approved by the bank, carrying a specific interest rate and possibly additional fees. Overdraft protection is typically used to cover temporary cash flow shortages or unplanned expenses.

Unauthorized overdrafts happen when the withdrawal exceeds the account balance without prior agreement, which usually results in higher fees and interest rates than those charged on authorized overdrafts. Banks often charge fees for each transaction that overdraws an account, plus daily or monthly fees as long as the account remains overdrawn. The cost of an overdraft can vary significantly between banks and according to the terms of the account. 

While convenient, frequent use of overdrafts can be costly and may indicate financial distress, suggesting the need for better budget management or financial advice.

Example

Sarah checks her bank account and sees an account balance of $50. She forgets about a pending automatic bill payment of $100 scheduled for that day. When the bill is paid, her account becomes overdrawn by $50, resulting in overdraft fees charged by her bank.

Key Articles Related To Overdraft

• Overdraft Protection: How It Works And How To Avoid Fees
• 8 Fees You Should Never Pay For

Related Terms

Line of Credit: A pre-approved amount of credit provided by a financial institution that a borrower can draw upon as needed.

Interest Rate: The amount charged by a lender to a borrower for the use of assets, expressed as a percentage of the principal.

Non-Sufficient Funds (NSF): A status of a checking account that does not have enough money to cover transactions.

Short-Term Loan: A loan scheduled to be repaid in less than a year.

FAQs

How can I avoid overdraft fees?

To avoid going into overdraft, keep track of your account balance, set up alerts for low balances, and link your checking account to a savings account for automatic transfers. While it takes some planning, it's also wise to build an emergency fund, so that you can be better prepared for unplanned expenses. 

What is overdraft protection?

Overdraft protection is a service offered by banks that acts as a very short-term loan and covers any overdrafts, often up to a specific limit. There is usually a fee associated with this service. 

Are overdrafts bad for my credit score?

Overdrafts do not directly affect your credit score unless the account remains overdrawn for an extended period, and the bank turns the debt over to a collection agency. However, frequently overdrawing your account can indirectly influence lender decisions.