Overdraft

"I warn you, Sir! The discourtesy of this bank is beyond all limits. One word more and I—I withdraw my overdraft."

Cartoon from Vol. 152, June 27, 1917

An overdraft occurs when withdrawals from a bank account exceed the available balance; i.e. over-drawings. This gives the account a negative balance and in effect means the account provider is offering credit.

If there is a prior agreement with the account provider for an overdraft facility, and the amount overdrawn is within this authorised overdraft, then interest is normally charged at the agreed rate. If the balance exceeds the agreed facility then fees may be charged and higher interest rate might apply.

Overdrafts in the US

Most overdrafts due to customer error are due to the customer forgetting a bank delay in check deposits, forgetting Automatic Withdrawals for various bills, or simple ignorance of their actual account balance.

Bank policy greatly affects the bank's ability to charge overdraft fees. Some banks alter the order in which transactions are applied during the day to maximize overdraft fees. For instance, if there is $100 available and withdrawals in the amounts of $1, $5, $7, $10, and $105 are all posted in the same batch, many banks will post the larger withdrawals first, causing 5 overdraft fees. In contrast, if these withdrawals are applied in the order above, only the last withdrawal will overdraft, and only one fee will be assessed.

Some consider overdraft charges to be unethical in the case of electronic funds transfer, debit card, credit card or other transactions electronically authorized by the bank or other financial institution. Bank policy determines when a bank will authorize a transaction, and many banks permit transactions far in excess of the available account balance.

Many see this practice as a type of predatory lending by allowing consumers to spend money that they do not have. Although traditional overdraft lines of credit are loans, federal reguladors do not consider modern "discretionary" overdraft protection programs to be loans because banks reserve the right to refuse to cover an overdraft at any time and for no reason at all. Recently, Congressional efforts have been made to bring overdraft charges under the requirements of the Truth-in-Lending Act (TILA). This would require more detailed disclosure of the terms of overdraft protection programs.

Overdrafts in the UK

Banks in the UK often offer a basic overdraft facility to a fixed amount of say 100 UK pounds. However, whether this is offered free of interest, subject to an average monthly balance figure or at the banks overdraft lending rate varies from bank to bank.

Breaching such a limit invariably incurs penalties and banks operate various policies. Typically any item presented that would take a customer over his limit is often declined and fixed penalty charge is applied. In other cases, the item presented is accepted with the bank then charging an unauthorised overdraft penalty.

In 2006 the Office of Fair Trading found that the banks were exploiting penalty bank charges on credit cards and has suggested that banks restrict such penalty to a maximum of 12 UK pounds. Penalty charges or Liquidated damages are illegal in UK contract law unless they represent the real cost of a breach of contract incurred through an unauthorised overdraft level or bounced cheque. This ruling by the OFT has been extended by many customers to their personal bank accounts and currently the UK small claims court system is flooded with cases of customers reclaiming these ‘illegal’ penalties. To date no bank has appeared in court to justify its penalty charges and most customers have recovered such charges in full.

Overdraft

Overdrafts in the US

Overdrafts in the UK

See also