Overdraft – what is it, types, advantages and disadvantages of overdraft

Cash loans, relevant for bank customers, can be obtained in various ways. One of these ways is overdraft.

Detailed information about the relevant financial service, the specifics of its use and the essence of this banking instrument, its classification, advantages and "pitfalls" is provided below. This material also includes professional recommendations on obtaining the relevant type of service from financial and credit institutions and its competent use.

What is an overdraft?

Overdraft – a type of crediting of a client’s account by a banking institution for the purpose of paying for settlement documents in the event of a shortage or absence of funds in the client-borrower’s account.

Literal translation of the word overdraft in English it sounds like "overspending on the account."

Bank overdraft occurs in a situation where a client exceeds the available cash balance in their account during electronic transfers, card, check transactions, and other transactions, i.e., actually goes into the "minus".

In this case, the balance of the individual or legal entity becomes negative. This amount exceeding the limit is considered an overdraft.

Credit overdraft services are provided by many banks. However, they most often involve the collection of fees or interest. At the same time, such a credit and financial product has differences that distinguish it from other types of loans, including consumer and mortgage loans:

1. Short, limited term of use – an overdraft is temporary and is provided for a certain period of time.
2. Comparative ease of design.
3. Lack of a specific purpose.

Get it now overdraft on current account in various Ukrainian banks is available to their clients of many categories, including large commercial and industrial organizations, individual entrepreneurs and individuals who receive social payments or wages to their account in a banking institution. Such a loan is also provided for deposits.

The service of some financial institutions provides automatic overdraft credit line, but using it involves a service fee in the form of high interest.

Types of overdraft

There are two basic categories of such a credit and monetary product - authorized and unauthorized.

In turn, an authorized overdraft can be standard or limited.

The standard version involves the bank client pre-determining permission for a negative balance. In this case, an agreement is concluded in advance between this person and the financial institution, which precisely specifies the specific overdraft limit.

An overdraft loan is said to be limited authorized when the bank sets a maximum negative amount that the account holder can use. When determining this, various individual circumstances may be taken into account, including the borrower's financial situation and credit history.

The highest overdraft fees, are usually charged when the service is unauthorized and unspecified. This phenomenon is also called a "bad" or unauthorized overdraft. It occurs when a person's expenses exceed the amount available in the account, and a prior agreement with the bank did not take place.

If a bank client issues a check or writes off funds of another type, the amount of which is higher than the actual amount in his account, this is also a variant of an unauthorized corresponding financial product.

There are also several types of overdrafts according to the purpose of their accrual, briefly described in the list below.

1. Classic. There are no purposes for provision as such, but the basis for it is an agreement concluded between a banking institution and its client. Overdraft limits classically depend on the monthly turnover of funds in the current account.
2. Advance. A loan that is provided mostly to legal entities to provide financial coverage in the event of a lack of funds to advance expenses, i.e., settlement and cash services.
3. Collection. The credit amount is intended to fulfill the collection obligations of the payer-enterprise or to carry out other financial transactions. It is provided to companies in which about 75% of cash turnover falls on collected revenue.
4. Salary. Limited funds used while waiting for a salary that arrives regularly.
5. Technical. Overdraft terms and conditions The technical specifics that are performed automatically are financial and technical failures in the bank client's account.

An overdraft loan can be automatically connected to a card that systematically receives social security payments or salaries.  

Advantages of overdraft

This credit and banking service has several priority features that have made it popular.

1. Efficiency and convenience. This is a rational and effective method for short-term financial planning and solving problems of unforeseen expenses.
2. Accessibility. This service provides easy access to the necessary additional funds in a situation where financial difficulties arise.
3. Favorable terms of receipt. Overdraft interest rate authorized, which is provided based on a prior agreement with a banking institution, may be minimal.
4. Ability to avoid fines. This service of financial institutions is relevant to prevent fines, the cause of which is insufficient funds in the account to perform the necessary payment or other transactions.
5. Automatic and instant repayment of overdraft debt with money replenished in the debtor's account.

The obvious advantages of the corresponding service include the speed of payments without the need for additional documentation and the ability to receive overdraft without collateral, unlike most types of credit.

In modern conditions, a positive aspect of using this banking service is its remote activation or deactivation in an online format using an application on the Internet. By installing such an application, you can control the amount of debt and the processes of its repayment.

Disadvantages of overdraft

Using the overdraft service has several disadvantages that applicants for this service should take into account.

1. Dependence on the banking institution. The bank decides whether to grant or deny such a loan. This institution has the authority to change the terms of the overdraft loan at any time.
2. High overdraft interest rateDue to the significant interest and commission rates charged by many financial institutions, the user is likely to have an increase in total debt.
3. The likelihood of an unauthorized overdraft debt arising in unexpected cases. The consequence of such an undesirable situation, which can catch the client by surprise, is the accrual of high interest and penalties.
4. Risks of exceeding the established limits. In such cases, the payer is also subject to penalties, which result in additional costs.
5. Long-term debt. Such debt often arises in the case of frequent, constant use of the overdraft service as a source of financing.

Competence, which allows you to use such a loan banking service competently and correctly, taking into account its positive aspects and risks, will help to avoid the corresponding unpleasant nuances.

How to use an overdraft correctly?

Experts advise to adhere to a number of the following recommendations when using this financial instrument:

• carefully study all the terms and conditions in advance and familiarize yourself with the key, important aspects of the service (from the interest rate and commission to the repayment terms) in order to clearly understand, how does an overdraft work, and take this aspect into account;
• do not resort to overdraft without an urgent need - this is a reasonable and rational option for emergency situations, which should not become your main source of financing;
• choose a limit that meets your financial capabilities, not an overly high one that will be difficult to repay;
• timely, without delay, debt repayment - otherwise high interest will accumulate;
• Regular control, careful monitoring of the account - such tracking will help prevent exceeding the limit.

The best option for arranging an overdraft is an authorized type of the relevant financial and credit service. It will help prevent unauthorized, additional expenses.

How to get an overdraft?

To do this, you should conclude an overdraft agreement that regulates the conditions and mutual obligations between the financial institution and its paying client.

The relevant contract has the status of a legal document.

It provides for the possibility of using a current bank account with an overdraft as a loan or financial reserve in cases where the amount of money available on it is insufficient to cover necessary expenses.

That is, this loan agreement gives the client permission to temporarily use funds that exceed his actual balance, increasing his account limit using the appropriate method.  

To draw up an overdraft agreement with a bank, you need to prepare a package of documents that includes several components.

1. Service request.
2. Passport of a citizen of Ukraine (the original is presented, and a copy is provided).
3. Identification code.
4. Documentation confirming the applicant's income (this may be an income certificate, work record book, tax payment report).
5. Official certificates certifying work experience and place of residence.
6. Credit history.
7. Registration or housing document.

This service is available to holders of bank accounts, deposits, and individuals with regular payments received on the card.

Is it possible to increase the overdraft limit?

The banking institution may make such a decision in the event of an increase in the inflow of funds to the debtor's account. The bank may also reduce the relevant limit in the event of a decrease in the relevant cash inflows.

The relevant points are usually agreed upon when concluding an agreement between a credit and financial institution and its client, and are recorded in this document.

What is the difference between an overdraft and a credit card?

A credit card is a payment and settlement document that serves to pay for goods and services on credit by using the amount of funds reserved by the bank for these financial, non-cash and cash transactions, i.e. the credit limit. The loan provided by this card can be completely free. And for its registration, a passport and TIN are enough.

The difference between an overdraft and a credit card is that more documents are required to apply for it, and it is repaid, that is, such a debt is written off automatically with all amounts that are credited to the borrower's account. To repay such a loan, you can top up the account yourself.

Is it possible to close an overdraft if the amount has not been used?

This option for customers, which results in disabling overdraft or setting the limit to zero, is provided by many banking institutions.

After executing the corresponding option, automatic use of an amount exceeding the funds available in the account will become impossible.

How to withdraw funds from an overdraft?

This transaction, provided that the corresponding service is registered at the bank, is carried out in the usual mode.

It is worth knowing that sometimes a financial institution may refuse to provide an overdraft. The basis for such a decision is the borrower's lack of income, a bad credit history, or the use of funds for transfer to an account at another bank.