An overdraft is technically an allowance given to a client by a financial institution. This allows them to continue withdrawing money from their account despite depletion of all their funds. It is a type of loan because the client obtains money on credit terms from the bank, before repaying on a later date. Overdrafts are a short term form of financing. The amount available to a client depends on many factors. These factors include the policies of specific institutions and the type and value of the account held by the client.
How Overdraft Loans Work
Financial institutions basically use two methods to cover for an overdraft. First they can decide to use their own money and this means that the it will not affect the client’s credit rating. The other option is to attach the credit to your credit card and this will affect your credit score especially if you default or delay repaying.
Another feature of overdraft loans is the overdraft protection, which provides a client with a tool to control their checking account. This is what gives the client an allowance to spend more than what they have in their accounts. The main reason for this allowance is to assist when emergency situations come up. Besides, it also prevents clients from having their checks bounce since the amount credits as an overdraft. A fee attaches to this facility to curb misuse. It also provides an additional source of income to the lending institution. If the institution sense an imminent misuse they have a right to withdraw the overdraft protection from the client’s account.
Types of Overdraft Loans
There are two main types of overdrafts. They are the authorized and the unauthorized overdrafts. An authorized overdraft is the type where the institution sets the overdraft limit after consulting with the client. The client withdraws via normal means without exceeding the amount agreed. Unauthorized overdraft on the other hand is mostly experienced on current accounts which do not have a minimum balance requirement. An institution considers a negative balance to be an overdraft. The account therefore attracts a penalty.
Client consider overdraft loans to be a huge favor by financial institutions. It assures they can get money for emergency use without having to go through the long process of loan application. It curbs the temptation of going for money sharks that promise quick turnaround loans, but end up frustrating their clients. The client’s financial status usually limits the overdraft amounts. This status includes account balance and cash flow. The fees levied above the overdraft amount differ from bank to bank and this means that one should get the right information first before deciding to request for an overdraft protection.