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What is Overdraft? How does it Work?

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A financial service called an overdraft is provided by banks and enables customers to take more money from their accounts than they currently have available.

When a customer’s account balance is inadequate to finance a transaction or withdrawal, it functions as a short-term credit facility, giving them rapid access to money.

Overdrafts are frequently utilised to deal with brief cash flow problems or unplanned expenses.

How an overdraft works?

Here is a list of explanations of how an overdraft operates.

  • Pre-Approved Credit Limit

The account holder must have a pre-approved credit limit determined by the bank in order to be eligible for an overdraft. Based on the account holder’s creditworthiness and banking relationship, this limit is decided.

  • Overdrawing the Account

The overdraft is triggered when the account holder makes a transaction or withdraws money that is greater than the available account balance. The bank makes up the difference, enabling the transaction to go through properly.

  • Interest and Fees

For as long as the overdraft balance is negative, the bank assesses interest on the amount. There can also be charges for using the overdraft facility, like an overdraft fee or a daily usage cost. The overdraft agreement’s terms and conditions contain information about these charges.

  • Repayment

Because overdrafts are meant to be used temporarily, the account holder is required to settle the overdraft as quickly as feasible. Most banks demand that the account get back to a positive balance in a certain amount of time, frequently in a few days or weeks.

  • Automatic Activation

Some financial institutions provide automatic overdraft protection, which means that if a transaction exceeds the available balance, the financial institution will immediately make up the difference, sparing the customer the inconvenience of having their transaction denied.

  • Linked to Checking Accounts

Since checking accounts are frequently utilised for daily transactions and payments, overdrafts are frequently connected to these accounts. Some banks might, however, additionally provide overdraft services for different kinds of accounts.

  • Responsible utilise

Account holders should utilise overdrafts cautiously even if they can be a useful financial tool in times of need. Relying on overdrafts frequently or going over your credit limit might result in the accumulation of high-interest fees and charges, which can be very expensive.

Conclusion

Account holders must be informed of the terms and circumstances governing their overdraft facility and utilise it wisely to prevent unforeseen costs. Overdrafts should be viewed as a short-term fix rather than a replacement for sound money management or long-term credit requirements.

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