Loading the player...

What is an 'Overdraft'

An overdraft is an extension of credit from a lending institution when an account reaches zero. An overdraft allows the individual to continue withdrawing money even if the account has no funds in it or not enough to cover the withdrawal. Basically, overdraft means that the bank allows customers to borrow a set amount of money.

BREAKING DOWN 'Overdraft'

With an overdraft account, your bank covers checks that would otherwise bounce and get returned without payment. As with any loan, you pay interest on the outstanding balance of an overdraft loan. Often, the interest on the loan is lower than credit cards. In many cases, there are additional fees for using overdraft protection that reduce the amount available for overdraft protection, such as insufficient funds fees per check or withdrawal.

Overdraft and Your Credit Score

Your bank can opt to use its own funds to cover your overdraft. Another option is to link the overdraft to a credit card. If the bank uses its own funds to cover your overdraft, then it typically won't affect your credit score. When a credit card is used for the overdraft protection, it's possible that you can increase your debt to the point where it could affect your credit score. However, this won't show up as a problem with overdrafts on your checking accounts.

If you don't pay your overdrafts back in a predetermined amount of time, your bank can turn your account over to a collection agency. This collection action can affect your credit score and get reported to the three main credit agencies. It depends on how the account is reported to the agencies as to whether it shows up as a problem with an overdraft on a checking account.

Overdraft Protection as a Useful Tool

Overdraft protection provides you with a valuable tool to manage your checking account. If you forget to take out money for a trip to Starbucks, overdraft protection ensures that you don't have a check returned and reflect poorly on your ability to pay. However, banks charge a fee and make money from this service; make sure you use the overdraft protection sparingly and only in an emergency situation.

The dollar amount of overdraft protection varies by account and by bank. In some cases, the customer needs to request the addition of overdraft protection. If the overdraft protection is used excessively, the financial institution can remove the protection from the account.

RELATED TERMS
  1. Overdraft Protection

    Overdraft protection is a fund transfer or loan that banks offer ...
  2. Overdraft Cap

    An overdraft cap is the maximum dollar limit that a bank will ...
  3. Checking Account

    A checking account is a deposit account at a financial institution ...
  4. Evergreen Loan

    An evergreen loan is a loan that does not require the principal ...
  5. Facility

    A facility is a formal financial assistance program offered by ...
  6. Non-Sufficient Funds (NSF)

    Non-sufficient funds is a banking term indicating that an account ...
Related Articles
  1. Personal Finance

    Differences Between Overdraft and Cash Credit

    Overdraft and cash credit differ in how they are secured and whether the money is lent out of a separate account.
  2. Personal Finance

    When Good People Write Bad Checks

    Overdraft protection can help when you overestimate your balance, but it will cost you.
  3. IPF - Banking

    How Overdraft Fees Work and How to Avoid Them

    Overdraft fees in checking accounts can mount up quickly. Here are four ways that account holders can avoid them.
  4. Personal Finance

    Bank Overdraft Changes: What You Need To Know

    New laws to protect consumers should be in place by the summer. Find out what will change and how it could affect you.
  5. Personal Finance

    7 More Things Your Banker Doesn't Want You To Know

    Your banker is not your friend, and the more you know about their motives, the better you can protect your money.
  6. Managing Wealth

    Changes To Your Checking Account

    Checking accounts have evolved a lot over the years. Here are the five biggest changes that can affect your wallet.
  7. Personal Finance

    4 Reasons To Increase Your Credit Card Limit

    It seems contrary to smart financial planning, but increasing your credit limit can actually be a smart move.
  8. Investing

    Best Checking Accounts for Small Businesses

    Accounts with big banks offer frills, such as mobile and text-based banking but for smaller businesses, local banks and credit unions can save money.
  9. Personal Finance

    Lines of Credit: The Basics

    Learn how lines of credit, hybrids of credit cards, and normal loans, can help or hurt your finances. Determine what is right for you.
RELATED FAQS
  1. Debit card versus credit card

    Can't figure out which card to use when making a purchase decision? Here is everything you need to know about the differences ... Read Answer >>
  2. How do mortgage lenders check and verify bank statements?

    Find out how mortgage companies verify your bank statements for mortgage approval. The lender sends a form to your bank requesting ... Read Answer >>
Trading Center