how overdrafts work

How Overdraft Works? Types, Limit, Cost

If you are looking for a significant source to know what an overdraft is, how overdraft works, its types and costs. Then you just have found the right post. We will try to cover all the basic knowledge about an overdraft in an understandable and easy language. So, Let’s start!

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What is an Overdraft?

A short-term financial loan is known as an overdraft. When your account balance falls below zero, it permits you to obtain a temporary credit facility. An overdraft on your current account is usually granted, depending on your credit history.

If your bank allows you to take out an overdraft, you can spend more money than the current balance. Furthermore, it is a loan that you must repay to the bank, including any interest or fees. Some banks may automatically provide you with an overdraft, while others require you to fill out a formal application. For instance, if you have no money in your bank account but apply for a £100 overdraft, you will leave with -£100 in your bank account. The overdraft is the amount that you withdraw from your zero account balance.


Types of Overdraft

Following are the types of overdrafts:

  • Authorised Overdrafts
  • Unauthorised Overdrafts

Authorised Overdrafts – They are also known as agreed overdrafts or arranged overdrafts. This overdraft has a fixed and agreed-upon limit that has been set at the time of account opening. It allows you to borrow (overdraw) up to a specific amount. So if your overdraft limit is £1500, for example, you can spend £1500 after you’ve spent all of your money in your bank account.

Unauthorised Overdrafts – They are also known as unarranged drafts and are not pre-agreedWithout agreeing upon the overdraft limit in advance, when you spend more than the total money in your bank account the unauthorised overdraft is used. These overdrafts are more expensive than arranged overdrafts.

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How Overdraft Works?

Overdraft is a type of loan borrowed through your running bank account by withdrawing more cash than you have (in your account). In other words, you can say that you are overdrawn.

Usually, you are charged for this. Your bank may give you an overdraft at the time of opening an account, or you may ask your bank for it. As it is a type of loan ( borrowing money). Therefore, it is better to find the easiest way to borrow money.


Limit and Cost of Overdraft

The limit can be between 10 pounds to thousands of pounds and is based on two things.

Financial situations – By checking the client’s credit record and revenue, some banks decide whether they can give you an overdraft and then decides the limit.

The willingness of the bank – The limit of an overdraft also depends on the willingness of a bank. Some banks offer overdraft with a standard limit. On the other hand, some banks let you spend money if you exceed the limit. Therefore, ask your bank about the limit.

Several interest charges are charged for overdrafts by the banks. Charged for unauthorised overdrafts are higher than authorised overdrafts. Some banks do not charge any fees and interest charges for authorised overdrafts ( up to a specific limit). Some charge less, and some charge many pounds. Therefore, charges vary from bank to bank.


Quick Sum Up

We hope that you have got enough information on what is an overdraft and how overdraft works. You need to keep this thing in your mind that your bank will allow you to use the overdraft facility on your current account, but you need to keep an eye on all of the factors to protect yourself against extra interest rates and fees.

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Disclaimer: This blog contains general information about an overdraft.


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