Overdraft

What is an Overdraft?

An overdraft is a term often used when a client of a bank overspends and their balance goes below zero. This often happens with checking accounts, and debit accounts associated with a debit card. 

The deficit could be "unplanned" or "unarranged", and there is usually a fee for it by the bank. In reality, an overdraft is a type of loan. 

Authorized overdraft

If you have signed an overdraft agreement with your bank, then the overdraft is not "unplanned". Businesses often use overdrafts, as they can have several big expenditures within a short period - for example, paying for a new shipment of materials, right after paying bonuses. In such cases, the account goes negative. In an arranged overdraft, there's interest and usually a solid plan to repay the loan. 

Overdraft protection

Overdraft protection is a service that helps you to stop the charges on your bank account, from being declined when you don't have enough money in your account. The service could also be called cash-reserve checking and is mostly used for checking accounts, but in some cases, it could be used for savings accounts as well. 

Overdraft protection is triggered when a transaction exceeds the available funds in your checking account. When you have overdraft protection, another account is linked to your checking account - for example, your savings account or your credit card. Funds are then transferred directly to your checking account and you can make the payment. However, the bank is most likely to charge you for this service, so there will be a fee in case of such a transaction.

Benefits of an overdraft

The overdraft can help you in the most dire of situations and support you in emergencies. It's a great financial tool and can certainly play a positive role in your finances. Relying on it too much though causes a serious risk of ending in a debt spiral. The fees for overdrafts are costly - especially for unauthorized overdrafts. Last, but not least, not covering your overdraft obligations and not repaying it properly can harm your credit score.