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What is a Bank Account Overdraft?

A bank account overdraft occurs when an account holder withdraws or spends more money than is available in their bank account. In other words, it’s a situation where the account balance falls below zero, resulting in a negative balance. Overdrafts can happen for various reasons, such as unexpected expenses, insufficient funds to cover scheduled payments, or errors in account management.
When a bank account becomes overdrawn, the financial institution may provide an overdraft facility to cover the deficit temporarily. This typically involves extending credit to the account holder to allow them to complete transactions or access funds beyond their available balance, up to a predetermined limit.
Overdrafts are often associated with fees charged by the bank, including overdraft fees and/or interest charges on the overdraft amount. These fees can vary depending on the bank’s policies and the amount of the overdraft.
While overdrafts can provide temporary relief for account holders facing cash flow shortages, they can also lead to financial strain if not managed responsibly. Excessive use of overdrafts can result in accumulating fees, negative impacts on credit scores, and potential debt problems. Therefore, it’s important for account holders to monitor their account balances closely, budget effectively, and use overdrafts sparingly to avoid financial difficulties.

Types of Bank Account Overdrafts

The two types of bank account overdrafts are authorized and unauthorized overdrafts.

Authorized bank overdraft

With an authorized overdraft, the arrangement is made well in advance between the account holder and their bank. Both parties agree to a borrowing limit that can be used on all normal payment methods. Of course, the arrangement comes with a service fee that varies from bank to bank.

Usually, the fee is charged daily, weekly, or monthly, plus interest, which can be as high as a 15% to 20% annual percentage rate. Considering the sometimes very high fees, an overdraft arrangement can be very expensive, especially if the borrowed amount is very small. That is why account holders should be very careful to avoid overdrafts, even authorized ones.

Unauthorized bank overdraft

As the term implies, this means that the overdraft has not been agreed upon in advance and the account holder has spent more than his account’s remaining balance. Unauthorized overdrafts can also happen even if there has been a prior agreement, if the account holder has gone beyond the agreed overdraft amount.

Unauthorized bank account overdrafts incur higher fees, which makes them more expensive.