Overdraft Definition - Investopedia

An overdraft occurs when there isn't enough money in an account to cover a transaction or withdrawal, but the bank allows the transaction anyway. PersonalFinance Banking WhatIsanOverdraft? Anoverdraftoccurswhenthereisn'tenoughmoneyinanaccounttocoveratransactionorwithdrawal,butthebankallowsthetransactionanyway. Essentially,it'sanextensionofcreditfromthefinancialinstitution thatisgrantedwhenanaccountreacheszero.Theoverdraftallowstheaccountholdertocontinuewithdrawingmoneyevenwhentheaccounthasnofundsinitorhasinsufficientfundstocovertheamountofthewithdrawal. Basically,anoverdraftmeansthatthebankallowscustomerstoborrowasetamountofmoney.Thereisinterestontheloan,andthereistypicallyafeeperoverdraft.Atmanybanks,anoverdraftfeecanrunupwardsof$35. KeyTakeaways Anoverdraftoccurswhenanaccountlacksthefundstocoverawithdrawal,butthebankallowsthetransactiontogothroughanyway. Theoverdraftallowsthecustomertocontinuepayingbillsevenwhenthereisinsufficientmoney.Anoverdraftislikeanyotherloan:Theaccountholderpaysinterestonitandwilltypicallybechargedaone-timeinsufficientfundsfee.Overdraftprotectionisprovidedbysomebankstocustomerswhentheiraccountreacheszero;itavoidsinsufficientfundscharges,butoftenincludesinterestandotherfees. 1:26 Overdraft UnderstandingOverdrafts Withanoverdraftaccount,abankiscoveringpaymentsacustomerhasmadethatwouldotherwiseberejected,orinthecaseofactualphysicalchecks,wouldbounceandbereturnedwithoutpayment. Aswithanyloan,theborrowerpaysinterestontheoutstandingbalanceofanoverdraftloan.Often,theinterestontheloanislowerthantheinterestoncreditcards,makingtheoverdraftabettershort-termoptioninanemergency.Inmanycases,thereareadditionalfeesforusingoverdraftprotectionthatreducetheamountavailabletocoveryourchecks,suchasinsufficientfundsfeespercheckorwithdrawal. SpecialConsiderations Yourbankcanopttouseitsownfundstocoveryouroverdraft.Anotheroptionistolinktheoverdrafttoacreditcard.Ifthebankusesitsownfundstocoveryouroverdraft,ittypicallywon'taffectyourcreditscore.Whenacreditcardisusedforoverdraftprotection,it'spossiblethatyoucanincreaseyourdebttothepointwhereitcouldaffectyourcreditscore.However,thiswon'tshowupasaproblemwithoverdraftsonyourcheckingaccounts. Ifyoudon'tpayyouroverdraftsbackinapredeterminedamountoftime,yourbankcanturnoveryouraccounttoacollectionagency.Thiscollectionactioncanaffectyourcreditscoreandgetreportedtothethreemaincreditagencies:Equifax,Experian,andTransUnion.Itdependsonhowtheaccountisreportedtotheagenciesastowhetheritshowsupasaproblemwithanoverdraftonacheckingaccount. OverdraftProtection Somebutnotallbankswillpayoverdraftsautomatically,asacourtesytothecustomer(whilechargingfees,ofcourse.)Overdraftprotectionprovidesthecustomerwithafurthertooltopreventembarrassingshortfallsthatreflectpoorlyonyourabilitytopay. Usually,itworksbylinkingyourcheckingaccounttoasavingsaccount,othercheckingaccount,oralineofcredit.Ifthere'sashortfall,thissourcegetstappedforthefunds,ensuringthatyouwon'thaveacheckreturnedoratransaction/transferdeclined.Italsoavoidstriggeringa non-sufficientfunds(NSF)charge. Thedollaramountofoverdraftprotectionvariesbyaccountandbythebank.Often,thecustomerneedstospecificallyrequestit.Thereareavarietyofprosandconstousingoverdraftprotection,butonethingtobearinmindisthatbanksaren'tprovidingtheserviceoutofthegoodnessoftheirhearts.Theyusuallychargeafeeforit. Assuch,customersshouldbesuretorelyonoverdraftprotectionsparinglyandonlyinanemergency.Iftheoverdraftprotectionisusedexcessively,thefinancialinstitutioncanremovetheprotectionfromtheaccount. WhatIsanOverdraftFee? Anoverdraftisaloanprovidedbyabankthatallowsacustomertopayforbillsandotherexpenseswhentheaccountreacheszero.Forafee,thebankprovidesaloantotheclientintheeventofanunexpectedchargeorinsufficientaccountbalance.Typicallytheseaccountswillchargeaone-timefundsfeeandinterestontheoutstandingbalance. HowDoesOverdraftProtectionWork? Underoverdraftprotection,ifaclient’scheckingaccountentersanegativebalance,theywillbeabletoaccessapredeterminedloanprovidedbythebank,andarechargedafee.Inmanycasesoverdraftprotectionisusedtopreventacheckfrombouncing,andtheembarrassmentthatthismaycause.Additionally,itmaypreventanon-sufficientfundfee,butinmanycases,eachwilltypeoffeewillchargeroughlythesameamount. WhatAretheProsandConsofOverdrafts? Theprosofoverdraftinvolveprovidingcoveragewhenanaccountunexpectedlyhasinsufficientfunds,avoidingembarrassmentand"returnedcheck"chargesfrommerchantsorcreditors.Butit'simportanttoweighthecosts.Overdraftprotectionoftencomeswithasignificantfeeandinterestwhich,ifnotpaidoffinatimelymanner,canaddanadditionalburdentotheaccountholder.AccordingtotheConsumerFinancialProtectionBureau,customerswhohadoverdraftprotection,infact,oftenpaidmoreinfeesthanthosewithoutit. ArticleSources Investopediarequireswriterstouseprimarysourcestosupporttheirwork.Theseincludewhitepapers,governmentdata,originalreporting,andinterviewswithindustryexperts.Wealsoreferenceoriginalresearchfromotherreputablepublisherswhereappropriate.Youcanlearnmoreaboutthestandardswefollowinproducingaccurate,unbiasedcontentinour editorialpolicy. ConsumerFinancialProtectionBureau."CFPBUnveilsPrototypesof"KnowBeforeYouOwe"OverdraftDisclosureDesignedtoMakeCostsandRisksEasiertoUnderstand."AccessedOct.18,2021. RelatedTerms HowDoesaCheckingAccountWork? Acheckingaccountisahighlyliquiddepositaccountheldatafinancialinstitutionthatallowsdepositsandwithdrawals. more WhyOverdraftProtectionMatters Overdraftprotectionisafundtransferorloanthatbanksoffertocustomerstocoverchecksordebitslargerthantheiraccountbalances,soastoavoidnonsufficientfundsfees. more Non-SufficientFunds(NSF) AnNSFfeeornon-sufficientfundsfeeoccurswhenabankaccountdoesnothaveenoughmoneytocoverapayment.ReadaboutNSFfeesandhowtoavoidthem. more BouncedChecksExplained Abouncedcheckisslangforacheckthatcannotbeprocessedbecausethewriterhasinsufficientfunds. more WhatIsaCashAdvance? Acashadvanceisaserviceprovidedbycreditcardissuersthatallowscardholderstoimmediatelywithdrawasumofcash,oftenatahighinterestrate. more LinkedTransferAccount Alinkedtransferaccountiswhenaccountsheldbyanindividualatafinancialinstitutionareconnectedtoeachother. more PartnerLinks RelatedArticles MoneyMarketAccount WhatIsaCD-SecuredLoan? 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