Overdraft

What is an overdraft?

An overdraft facility is a short-term credit extension linked to your checking or savings account. It lets you withdraw or spend more than your account balance, up to a pre-approved limit. This helps you with life's unexpected expenses that can catch you off guard.

How does an overdraft work?

When an account holder writes a check, makes a payment, or withdraws cash that exceeds the available balance in their account, the bank automatically covers the shortfall up to the agreed overdraft limit. This means the account balance will temporarily turn negative.

The account holder is expected to repay the overdrawn amount and any applicable interest and fees within a specified period. If the account holder fails to repay, the bank may impose penalties, or the overdraft facility could be revoked.

Types of overdrafts 

There are generally two types of overdrafts: 

• Secured Overdraft: This type of overdraft is backed by collateral, such as fixed deposits, shares, or other assets.  
• Unsecured Overdraft: An unsecured overdraft does not require any collateral, making it riskier for banks, but attracts higher interest. 

Benefits of utilizing overdrafts 

Overdrafts can be particularly helpful for individuals: 

• Prone to Fluctuating Income: Individuals with variable income streams can utilize overdrafts to manage occasional cash flow gaps. 
• Managing Recurring Expenses: Overdrafts can help cover essential bills or recurring payments due before your next paycheck arrives. 
• Building Credit History: Responsible overdraft usage and timely repayments can be a good way to build a positive credit history, especially for young adults. 

Key terms related to overdraft 

1. Overdraft Limit: The maximum amount you can overdraw from your account. 
2. Overdraft Interest Rate: The interest charged on the overdrawn amount. 
3. Overdraft Fee: A fee charged each time the overdraft facility is used. 
4. Negative Balance: The account balance when the overdraft facility is utilized. 
5. Repayment Period: The time frame within which the overdrawn amount must be repaid.

How is an overdraft different from a loan? 

While both overdrafts and loans provide access to extra funds, they serve different needs. A loan offers a fixed sum with a structured repayment plan, ideal for long-term financing. An overdraft, however, is a revolving credit facility allowing you to withdraw up to a set limit as needed, offering flexibility for short-term needs. 

Making the most of overdrafts

• Track Your Spending: Regularly monitor your account to avoid frequent overdrawing. 
• Use Sparingly: Rely on overdrafts only for emergencies or short-term needs, not as a financial strategy. 
• Explore Alternatives: Consider savings transfers or a credit card with a grace period for purchases.

While overdrafts have their benefits, credit cards are an equally good alternative because of their flexibility and security features. And, if you are on the lookout for one, consider our 811 Credit Card or Dream Different Credit Card, which offers a range of benefits and credit score-building avenues and can be obtained against a fixed deposit.