An overdraft is a short-term loan that allows you to spend more money than you have in your bank account. Banks often offer overdraft protection, which means that if you spend more money than you have, the bank will cover the difference and charge you a fee.
Types of Overdraft
There are several types of overdraft, each with its own set of terms and conditions.
1. Prearranged Overdraft
This is a pre-approved overdraft facility that you can use up to a certain limit. You typically have to apply for this type of overdraft and it will be subject to a credit check.
2. Unarranged Overdraft
This type of overdraft occurs when you spend more money than you have in your account without having a pre-arranged overdraft facility. Banks may or may not approve unarranged overdrafts, and they often charge high fees.
3. Paid-In Overdraft
This is a type of overdraft that is specifically designed for businesses. It allows businesses to overdraw their account to cover short-term cash flow needs. The overdraft is typically repaid within a short period, such as a day or two.
4. Bank Overdraft
This type of overdraft is offered by banks and is usually linked to your current account. It allows you to make payments or withdraw cash even if you have insufficient funds in your account.
5. Merchant Overdraft
This type of overdraft is offered by some merchants, such as retailers. It allows you to make purchases on credit, even if you do not have enough money in your account to cover the cost of the purchase.
Key Points to Remember
- Overdrafts are typically expensive: Banks charge high interest rates and fees on overdrafts.
- Overdrafts can damage your credit score: If you frequently use overdrafts, it can indicate that you are having difficulty managing your finances, which can hurt your credit score.
- Overdrafts are a short-term solution: Overdrafts are not intended to be used as a long-term borrowing solution.
It's important to understand the terms and conditions of any overdraft facility you use, including the interest rates, fees, and repayment terms.