Bank overdrafts take place when you do not have enough money in your account to cover a transaction, but the bank pays for the transaction. It is provided to some customers by the bank in the form of an extended credit facility, which comes into effect once the main balance of the account reaches zero. It is a type of financial instrument. Therefore, a bank guarantee format is an unsecured form of credit that is used for covering short-term cash requirements.
Banks offer a credit limit to the bank customers based on their relationship with the bank. The bank levies separate interest and charges towards non-maintenance of account. The interest rate for the overdraft facility may differ from bank to bank.
There are two types of bank overdrafts are authorized and unauthorized overdrafts.
1. Authorized bank overdraft
The arrangement is made between the account holder and their bank in advance. Both parties agree to a borrowing limit that can be used on all normal payment methods. Of course, the arrangement comes with a service fee which can vary from bank to bank.
Usually, the fee is charged daily, weekly, or monthly, plus interest, which can be as high as a 15% to 20% annual percentage rate. Considering the sometimes extremely high fees, an overdraft arrangement can be expensive, especially if the borrowed amount is small. That is why account holders should be careful to avoid overdrafts, even authorized ones.
2. Unauthorized bank overdraft
An unauthorized bank overdraft is when a bank has not agreed to the account holder has spent more than his account’s remaining balance in advance.
Unauthorized overdrafts can also happen even if there has been a prior agreement if the account holder has gone beyond the agreed overdraft amount.