Everything you need to know about bank overdraft

All you need to know about bank overdraft

Many people don't understand how bank overdrafts work. In fact, the bank overdraft is a possibility offered by banks to their customers in order to allow them to spend more than they have in their account.

This service is not free, it bears costs. This margin works like a bank loan is that it bears interest. In this guide, I show you how to manage your bank overdrafts in order to avoid some unnecessary bank charges.

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?? What is a bank overdraft?

A bank overdraft is a line of credit that covers your transactions if your bank account balance falls below zero. This unsecured line of credit is designed to cover short-term cash flow shortfalls.

Overdrafts are useful when you need to proactively manage common cash flow situations.

As an example, you are in a store and you want to make a purchase for an amount of 80 euros and your balance is insufficient by 10 euros. What's going to happen ?

The bank will authorize your purchase and assume that you owe them $10. In other words, you have an overdraft of 10 euros on your account.

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When this overdraft facility is not arranged in advance, banks charge what is known as an 'account overdraft fee'. Thus, there are several types of bank overdrafts.

?? Types of bank overdraft

Two types of bank overdrafts are available to you: authorized overdrafts and unauthorized overdrafts.

Authorized overdrafts

Authorized overdrafts are arranged in advance with the bank. They are therefore also called “arranged” overdrafts. You agree with your bank on an overdraft limit that you must respect. Your bank will charge you interest and sometimes other fees on top of that.

Unauthorized overdrafts

They are also called “unplanned” or “unarranged” overdrafts. They happen when you spend more than you have in your bank account without prior approval. This includes exceeding the limit of an authorized overdraft.

?? Bank overdraft fees

The most common charges in a bank overdraft are the simply named overdraft charges. They occur whenever the bank approves a transaction that exceeds your available balance.

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Generally, banks do not charge overdraft fees when you have an overdraft of less than $5. Broadly, there are 4 types of fees associated with a bank overdraft.

Non-Sufficient Funds (NSF) charges

NSF charges occur whenever the bank chooses to deny you overdraft. Virtually all banks charge the same amount for overdrafts and fees for FNS. Both are often charged as one amount in your fee schedule.

Since a bank must choose between approving and rejecting an overdraft, a single overdraft will cost you either overdraft fees or FNS fees, but never both. However, a few banks distinguish between the two fees when counting the daily maximum.

Overdraft protection fees

Overdraft protection fees are charged each time the bank arranges a transfer from another of your accounts to cover the overdraft. This account is usually a savings account. These fees are also called overdraft fees.

Legally, banks cannot include overdraft protection as an automatic account service. Customers must therefore choose whether or not to activate this feature.

Banks online often offer free overdraft protection. But if you're at a standard bank, you can expect to pay between $10 and $12,50 per transfer.

While this may save you money compared to paying overdraft or NSF fees, if the bank's policy does not include mandatory notifications for each overdraft transfer, you may end up depleting your savings before to realize what is happening.

Extended overdraft fees

The final fee in the arsenal of overdraft penalties is the extended overdraft fee. These fees are sometimes referred to as extended overdraft fees or extended overdraft balance fees.

They come into play when you leave your account balance negative for a certain number of days. And that is what many people have in common.

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In most cases, you have 5 business days or 7 calendar days to fix your balance before extended overdraft fees put your account even deeper into the red. So be very careful with your balance.

Some banks charge this fee once every 5 days. Others go so far as to assess charges every day until you bring your balance above zero. The maximum number of extended overdraft charges you can incur varies by bank.

However, there are techniques to limit or avoid these fees. I explained in one of my articles how to avoid certain bank charges in general and bank overdraft charges in particular. Click here on cow to avoid high bank charges?

Besides that, here are my tips as a financier to better manage your bank overdrafts.

?? My tips for controlling your bank overdraft

As I mentioned at the beginning of this article, poor management of the bank overdraft can lead to high fees for the account holder. Here are my tips for better managing your bank overdraft.

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Keep an eye on your account balance

It may seem obvious, but keeping track of your account balance is one of the best ways to avoid overdraft fees.

Make it as simple as possible by:

  • Downloading your bank's app to your phone
  • Setting up text alerts when your balance is low
  • Using telephone banking.

Keep reading letters from your bank

It's easy to get into the habit of not opening letters from the bank and assuming it's just routine correspondence.

It is important to check all letters as the bank may write to you to inform you of a change in your overdraft limit or an increase in your overdraft interest rate.

Use the savings if you have any

If you have savings as well as an overdraft, it will cost you less in the long run to use your savings to pay it off. If you then get an unexpected cost, you can always use your overdraft to pay for it. And if you don't, you can start building up your savings again, so you're prepared for that unexpected expense.

Find ways to live on a budget

To reduce your overdraft as quickly as possible, reducing in other places will help you free up some cash. The money you save can then be used to pay off your overdraft.

Change bank

Switch to a bank account with lower overdraft fees. If you dip into your overdraft often, shop for the one with the lowest fees. You may even be able to switch to an account with a switching bonus, which will help clear your overdraft.

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?? The advantages of a bank overdraft

Several advantages are linked to using a bank overdraft. In this paragraph I present some of them to you. The bank overdraft allows you to:

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Managing the time mismatch of funds flows

A bank overdraft is generally best for businesses with more cash flow in a given period of time. An overdraft can help reset a cycle of skipped cash inflows and outflows.

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In other words, if sales and purchases result in money flowing in and out several times during a week/month; an overdraft facility makes it possible to manage cash discrepancies that may arise due to a time lag.

Help keep a good balance sheet

If a check was written based on a certain amount receivable, and if it is delayed, the check does not bounce due to insufficient funds. Therefore, the overdraft facility allows for a better payment history.

Make timely payments

It also guarantees timely payments and avoids late penalties as payments can be made even if the account balance is insufficient.

Avoid paperwork

It requires less paperwork that would typically be required in long-term loans because overdraft is easy to use.

Benefit from flexibility

The overdraft also has the advantage of being flexible. It can be taken at any time, for any amount (up to the allocated limit), and even for less than one or two days.

Benefit from lower interest charges

Interest is calculated only on the amount of funds used. Obviously if the amount of the overdraft is repaid on time.

This saves on interest charges compared to a normal loan taken out for a fixed period of time.

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Interest charges begin when you exceed your overdraft limit and stop instantly when paid off.

However, the bank overdraft is not "an angel". It also has drawbacks.

?? The disadvantages of bank overdraft

Each time you benefit from a bank overdraft, tell yourself that:

Interest rates can be very high

The overdraft facility has a cost. Sometimes this cost is higher than that of other funding sources. It is therefore important to consult the banking conditions of your bank before requesting an overdraft.

You risk reducing the number of overdrafts

The overdraft facility is a temporary loan that is regularly reviewed by the bank. Consequently, it runs the risk of a decrease in the number of withdrawals.

This reduction may be due to the poor performance of the company or the bad behavior of the account holder.

➤ You risk seizing

The bank overdraft facility may sometimes be collateralized against stocks or other collateral such as shares etc. The company may run the risk of these assets being seized if it fails to meet the payments.

Debtor collection can become sluggish

Sometimes the availability of overdraft facility can make the company less stringent in collecting payments from debtors.

In other words, a business may not have much incentive to collect payments from its debtors, as immediate payment outflows can be handled by an overdraft facility.

?? Summary …

The bank overdraft is an additional margin that you can benefit from in relation to your bank balance. It allows you to carry out transactions even when your bank balance is insufficient.

However, it can lead to costs if you do not master it. This guide has presented you with all the different charges related to this service that you may be subject to.

You are now equipped to better manage your bank overdraft. If you have any concern, then feel free to leave me a comment.

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