What is an overdraft?

An overdraft is an extension of credit from a credit institution that is granted when an account reaches zero. The overdraft allows the account holder to continue withdrawing money even when the account does not contain funds or does not have enough funds to cover the amount of the withdrawal.

Basically, an overdraft means that the bank allows customers to borrow a fixed amount. There is interest on the loan, and there are usually overdraft fees. In many banks, overdraft fees can be as high as $ 35.



How an overdraft works

With an overdraft account, a bank covers payments made by a customer that would otherwise be rejected or, in the case of real checks, rebound and be returned without payment.

Key points to remember

  • Overdraft protection is a loan made by some banks to customers when their account reaches zero.
  • The overdraft allows the client to continue to pay their bills even if there is not enough money in the client’s account (s).
  • An overdraft is like any other loan, the customer pays interest on the loan and, in the case of overdrafts, will usually have insufficient one-time fund charges.

As with any loan, the borrower pays interest on the outstanding balance of an overdraft loan. Often the interest on the loan is lower than the interest on credit cards, making overdraft a better short-term option in an emergency. In many cases, using overdraft protection results in additional charges that reduce the amount available to cover your checks, such as insufficient funds charges by check or withdrawal.

An example of overdraft protection

Overdraft protection provides the client with a valuable tool for managing their checking account. If you miss a few dollars on your rent payment, the overdraft protection ensures that you will not have a returned check for insufficient funds, which would not badly reflect your ability to pay. However, the banks provide the service because of the way they benefit from it, namely by charging fees. As such, customers should be sure to use overdraft protection sparingly and only in an emergency.

The dollar amount of overdraft protection varies by account and bank. There are advantages and disadvantages to using overdraft protection. Often, the customer must request the addition of overdraft protection. If overdraft protection is used excessively, the financial institution may withdraw protection from the account.

Special considerations

Your bank can choose to use its own funds to cover your overdraft. Another option is to link the overdraft to a credit card. If the bank uses its own funds to cover your overdraft, this will generally not affect your credit score. When a credit card is used for overdraft protection, you may be able to increase your debt to the point where it could affect your credit score. However, this will not appear as a problem with overdrafts on your checking accounts.

If you do not reimburse your overdrafts within a predetermined period, your bank can hand over your account to a collection agency. This collection action can affect your credit score and be reported to the three main credit agencies: Equifax, Experian and TransUnion. It depends on how the account is reported to agencies to find out if it appears to be a problem with an overdraft on a checking account.

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