What is an Overdraft

Many banking institutions have account management features that seem to benefit the customer, but many are also a way of generating revenue. Overdrafts are a common accommodation that banks make to help ensure a customer has the funds they need, even if they aren’t in their account. In fact, banks generated £1.2 billion of revenue from collected overdraft fees.1 Clearly, overdraft fees benefit more than just the customer. So what is an overdraft and how do you avoid the fees associated with it? Read on to learn more.

An overdraft occurs when the balance in your account does not cover the total of the transaction you need to make, but the transaction is still processed. This could happen with a checking, savings or money market savings account depending on your bank. After the transaction completes, the bank will typically charge a fee for the convenience.

Banks will differ in the transaction types that qualify for overdraft protection. Here are some examples of transactions that a bank will authorise for overdrafts:

• Checks or transactions using your checking account number
• Automatic bill payments
• Online banking transfers
• Recurring debit car transactions

Some examples of transactions the bank will not authorise without your request:

• ATM transactions
• One-time debit card purchases

It is possible to set up an arranged overdraft with your bank. The arranged overdraft is a limit predetermined by you and your bank — you have authorised certain purchases in advance (like the above examples). While opting in for overdraft protection doesn’t usually have a price, you will be charge based on usage, and you may potentially owe interest on the charge.

Additionally, if you’ve elected to participate in an arranged overdraft and go over your pre-determined amount, you could pay fees on top of the basic fees. This is one definition of unarranged overdrafts. If you don’t have any predetermined amount, you can still over withdrawal on your account and still get funds, but that is considered an unarranged overdraft. The fees are usually substantially higher for unarranged overdrafts than they are for arranged overdrafts. Approximately a fifth of account holders have unarranged overdrafts.1

Overdraft charges apply to customers’ monthly billing periods rather than the number of days over which the money is borrowed, which means customers can be charged for two billing periods. The resulting fees can add up to as much as £180.1

In short, overdraft protection may seem like a good feature to have on your bank account, but it can come at a steep cost. Take these precautions to avoid paying out big.

• Call your bank and find out if you were automatically enrolled in the overdraft protection program. Ask about the fees associated with it and determine if it’s truly worth it.
• Set up text alerts for your accounts when they drop below a certain balance. That way, you know if you’re getting close to £0 and can prepare accordingly.
• If you use automated bill pay, mark the auto-withdrawal date on your calendar and double check to make sure you have the funds in your account the day before.
• Avoid using your debit card to buy things like petrol, hotel rooms or car rentals. These types of businesses are likely to put holds or blocks on your account to make sure you can cover the full cost of the bill and then some. While the money doesn’t always leave your account, it could throw off the next few days until the funds are released back to you.
• If you have just encountered your first bank fee, call them — mistakes are common, and there is a chance they will refund you for the first slip-up. Ask them to waive it instead.

1-Dunkley, E. (7 February 2017). Bank overdrafts 8 times more costly than payday loans, study shows. Retrieved 20 February 2017, from https://www.ft.com/content/a5f68312-ed52-11e6-930f-061b01e23655