Lack of cash flow leads borrowers to get various forms of loans such as car loans, personal loans, business loans. These loans will definitely help you have enough cash to get things done. But there are some cases where you can get a cash flow without requesting a loan. This occurs especially when you do not have enough money in your bank account. This is where overdraft comes into play, letting you access cash flow as a debt you’ll pay later on.
What overdraft means, how it works, how to control it, etc are all-inclusive in this article.
What is Overdraft?
Overdraft occurs when the amount they withdraw from your account exceeds the balance in your bank account. A lending institution extends credit (overdraft) when a customer’s account reaches zero. Besides that, it is a type of loan. Also, overdrafts can allow you to borrow money when you need it, up to the limit that you agree with the bank.
How does it work?
Having known the meaning of overdraft, you would like to know how it really works. The overdraft allows you to borrow money through your current bank account. To do this, you take out more money than you have in your account balance. Overdraft lets customers withdraw money even when there is no money in their bank account. Or when they do not have sufficient funds to cover their withdrawal amount. For this to occur, the bank will charge you a certain amount of money and this can differ across banks.
However, in most cases, ask your bank for an overdraft. While sometimes they might just give you the overdraft to help you complete the purchase of what you need.
What are types of Overdraft?
There are two types of an overdraft that banks can grant their customers. They are:
- Authorised overdraft
They arrange this kind of overdraft in advance. They also call it the Arranged overdraft. You and your bank will agree to the limit of the fund they will offer you. Your bank will charge interest and (sometimes) other fees.
- Unauthorised overdraft
They do not arrange this type of overdraft, therefore they also call it ‘Unarranged’ or ‘Unplanned’ overdraft. It typically happens when you spend more than you have in your bank account. Even without agreeing to it in advance with your bank. Because of this, it implies going over the limit of an authorised overdraft.
What are the notable recent changes in Overdraft?
They made some notable changes on Overdraft recently, and this happened in April 2020.
The following are the recent changes:
- From April 2020, there will be no more higher charges from banks on unauthorised overdrafts.
- It will now be easier to compare charges between accounts. Because of this, they will charge interest on all overdrafts at a single annual interest rate (APR).
- The interest rates that banks and building societies can charge you on Overdraft can range from 19% to 40%.
What can I do if the changes do not favour me?
Change requires adaptation and because of this you could not find it easy to cope initially. But with time, you can adapt without too many struggles. However, if you think that these changes above will affect you, there are things you must do.
Do the following if you think the changes will affect you:
- Let your bank or building society know at once. They will explain everything for you to understand the benefits of those changes. However, your assumptions might be wrong, therefore, they’ll guide you appropriately.
- Explain your circumstances to your bank or building society. They will consider your situation and give you an adequate solution.
- Ask for help from your bank or building society if you feel those changes will make you struggle financially. If you struggle financially, you might fall into debts which will worsen your financial situation.
Do I really need It?
You might wonder whether you need an overdraft.
Overdraft helps customers a lot in making payments that are really necessary. It can also help them avoid fees that come with bounced or returned payments. And this happens when you try to make payments, but you don’t have enough money in your account.
Emergencies should make customers use overdrafts and also for a short-term option. This is because overdraft is a type of loan and you have to pay back timely. But if you know you can’t always pay back the overdraft. It would be more affordable for you to borrow using a personal loan or 0% credit card.
Ways to control your Overdraft
You might have an overdraft or wonder if you could control your overdraft. Of course, there are ways you can control your overdraft.
The following are ways you can control your overdraft:
- Closely watch your account balance
You already know what you have in your account balance. But it’s always better to always monitor your account balance to avoid the overdraft costs
- Read your bank’s letters
Do not take the letters from your bank for granted. Although it seems to be a routine circulation of one form of information or the other. Sometimes, they distribute important information that could benefit you. Check all those letters because your bank might write to tell you something. This could be about a change to your overdraft limit or increase to your overdraft interest rate.
- Use savings if you have them
Your savings will be cheaper for you to pay off your overdraft in the long run. Besides that, your savings always serve as a backup for some expenses you do not expect. And even if you don’t have an overdraft, your savings can help you make some payments.
- Live on a budget
You will always free up some money when you cut back in other areas you make expenses. Therefore, living on a budget is really important for you to repay your overdraft on time. Thereafter, the little savings you make after cutting back some expenses. You can now use the money to pay off the overdraft.
- Switch bank accounts
There are bank accounts that attract lower overdraft charges. And some of these accounts could have switching bonuses which could help you completely pay off the overdraft.
What are the pros and cons of Overdraft?
Just like every other type of loan, overdraft has some pros and cons. And this will encourage customers to accept or reject the overdraft. After seeing the pros and cons, you can decide which one makes more sense to you.
The pros of overdraft are:
- They rarely charge you for paying off the overdraft earlier than they expect it.
This is usually quite different from other types of loans. Where lenders will charge you some fees for paying off the loans ahead of the time, you agreed with them.
- It helps customers to make timely payments.
Customers who have overdraft rarely make late payments which can harm their credit scores. The overdraft protects the credit scores of customers. By ensuring that payments occur properly and when they need it. Besides that, it helps customers to avoid late payment fees to suppliers.
- The overdraft is flexible.
The nature of overdraft allows customers to borrow what they need. And this may make it cheaper than other types of loans.
The following are the cons of Overdraft:
- Uncertain interest rate.
The uncertain nature of the interest rates of overdraft makes it difficult for customers to know their borrowing cost.
- You can only access it from the bank where you have a current account.
You can not get the overdraft everywhere like other types of loans. It requires you to access it from the bank that already has your current account. For you to get an overdraft from another bank. They will require you to transfer your business bank account to the other bank.
- Charge for exceeding limit
The bank that offers you the overdraft could charge you if you exceed your overdraft limit. This usually happens when you exceed your limit without authorisation from your bank.
Most times banks or building societies do not report the debt you owe through overdraft to credit bureaus. Especially if you make timely repayments of your debts. And you gain these debts when your bank lends you the overdraft necessary to complete your financial transactions. However, only use the overdraft for short-term borrowing or emergencies. Whereby you can quickly repay the full debt and some other fees it could attract.