Overdraft Account Meaning [Banking Basics]

In this article, weโ€™re exploring overdraft account meaning, rules, and important factors to consider.

This article is part of our free series on how to open a bank account, which covers bank accounts for all possible scenarios, including when an account has been deemed dormant.

Feel free to use the table of contents to jump ahead to the sections most relevant to you.

Table of Contents

  1. Overdraft Account Meaning
  2. What Are the Pros and Cons of Overdrafts?
  3. What Is Overdraft Protection?
  4. Frequently Asked Questions
  5. Ready to Explore Your Options?

Overdraft Account Meaning

Overdraft account, meaning an account that extends credit to the account holder, is a useful tool to meet short-term financial obligations. That said, overdraft protection typically involves both fees and interest rates. So, before using an overdraft, account holders should confirm that they are comfortable with the fees being applied to their situation.

What is Overdraft Protection?

Overdraft protection refers to an agreed amount of excess charges that a bankโ€™s customer can incur on their checking account beyond their account balance. Not surprisingly, because an overdraft is an extension of credit, banks will perform a credit check on the customer before agreeing to issue a facility.

What are the Pros and Cons of Overdrafts?

In this section, weโ€™ll discuss the pros and cons of overdrafts. However, before diving in, itโ€™s important to review the specific terms and conditions being offered to you before agreeing to an overdraft as each bank is different. With this in mind, the specific pros and cons that may apply to one personโ€™s situation may not necessarily apply to yours.

Pros of a Bank Account Overdraft

Pros of a bank account overdraft include the access to excess capital that they can provide. Additionally, in most cases, bank overdraft facilities have a lower interest rate than other short-term forms of credit like a credit card. This makes them a suitable option for meeting short-term financial shortfalls.

Cons of Having an Overdraft Account

Cons of having an overdraft account relate to the interest rates and fees that are charged when it is used. This is especially true if an overdraft facility is not pre-arranged, as banks typically charge much higher fees and interest rates for using facilities that are not agreed to in advance.

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Frequently Asked Questions

Below are three of the most common questions that we receive from people looking into the meaning of an overdraft account. If you have further questions you would like answered, donโ€™t hesitate to get in touch with us directly.

Is Bank Overdraft a Type of Loan?

Yes, a bank overdraft is a type of loan because it is a form of credit that a bank customer can access. In most cases, bank overdrafts can be pre-arranged, which includes an agreed-upon interest rate and available amounts. However, in other instances, a bank overdraft can be not arranged, which typically incurs higher interest.

Why Is a Bank Overdraft a Liability?

A bank overdraft is a liability because it is a form of credit that the bank extends to certain customers. In other words, customers do not have the money available in their account at the time of purchase. So, the bank extends a short-term credit facility and covers the additional balance required to make a payment.

How Does an Overdraft Get Paid Back?

An overdraft can be paid by transferring funds from your checking (or savings) account to the overdraft account. If you do not have sufficient funds, you may want to use a lower-interest credit facility. If that is not an option, then coming up with a payment plan is an important first step. However, this requires you to consistently contribute to your overdraft.

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GlobalBanks Team
GlobalBanks Team

The GlobalBanks editorial team comprises a group of subject-matter experts from across the banking world, including former bankers, analysts, investors, and entrepreneurs. All have in-depth knowledge and experience in various aspects of international banking. In particular, they have expertise in banking for foreigners, non-residents, and both foreign and offshore companies.

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