Definition of Bank Overdraft
The term “bank account overdraft” refers to the situation in which an individual’s bank account balance drops to zero or below, resulting in a negative balance.
It often occurs when there is no more money available in the account in question. Yet, an outstanding transaction is completed via the account, resulting in the account holder accumulating a debt as a result. It is important to repay a debt because, when a transaction is overdrawn, a bank effectively loans the account holder the money necessary to complete it; this amount, as well as any costs, must be repaid. While they seem to be beneficial to the account holder, overdrafts may cause expenditures to spiral out of control if they are not dealt with swiftly and appropriately.
Overdraft Types
Authorized Bank Overdraft
With an approved overdraft, the agreement between the account holder and their bank is formed well in advance of the need for the money. Both parties agree on a borrowing limit that may be utilized with any of the standard payment options. Of course, there is a service cost associated with the arrangement, which varies from bank to bank. Typically, a daily, weekly, or monthly fee is paid and interest, which may be as high as a 15 percent to 20 percent annual percentage rate in certain instances. If one considers the often prohibitively high costs, an overdraft agreement may be very costly, particularly if the amount borrowed is little. As a result, account holders should exercise extreme caution regarding overdrafts, even those that are allowed.
Unauthorized Bank Overdraft
In this case, the overdraft has not been agreed upon in advance, and the account holder has spent more money than the account’s remaining balance. In addition, even if there has been a previous agreement, unauthorized overdrafts may occur if the account holder has gone past the agreed-upon overdraft amount.
Overdrafts on unauthorized bank accounts are subject to additional fees, making them more costly overall. Unauthorized overdrafts, also known as ‘unplanned’ or ‘unarranged’ overdrafts, occur when you spend more money than you have in your bank account without first getting permission from the bank to do so in advance. This involves going above the limit of an authorized overdraft, among other things.
How To Avoid Bank Account Overdraft
Paychecks should be deposited into your account via direct deposit. You will have access to your paycheck as soon as it is processed.
Ensure that you keep track of your account’s balance and transactions, and that you do not forget about automatic payments. It is now easier than ever to monitor your account balances and transactions online, via phone, or at an ATM, at any time of day or night. Some financial institutions also provide mobile banking, which allows you to check your account balance from your mobile phone. Be mindful of the fact that any transactions you authorized that have not yet reached and been processed by your bank will be excluded from those balances and will not appear on your statement.
Simply said, keep a “pad” or “cushion” of money in your bank account as a precautionary measure.
Connect your checking account to an overdraft line of credit, a savings account, or a credit card to avoid overdrawing your account. These are typically less expensive choices, but keep in mind that you will be required to repay any overdraft lines of credit or credit cards that you use. Most of the time, new deposits into your checking account do not automatically reimburse the amounts you owe.
Check with your financial institution to see whether you may “opt-out” of overdraft protection. However, according to ABA polls, most consumers prefer the assurance of knowing that their transactions would be covered, even if there is a cost involved.
Inquire with your bank about obtaining a limited line of credit to protect you if you overdraw your account. You must, however, ensure that you pay it back as soon as you receive the bill.
Check with your bank to see whether they provide automatic notifications when your balance falls below a certain threshold. You may be able to be notified via text message or email if this is the case.
If your current bank does not provide the services you require or charges excessive overdraft fees, you might consider switching banks. There are practically thousands of banks vying for your business, and each one is different.
Bank Charged Interest On Overdraft
To make it easier to compare costs between accounts, interest on all overdrafts is levied at a single annual interest rate (APR). Overdraft interest rates charged by banks and building societies range from 19 percent to 40 percent or more per month.
BANK OVERDRAFT DEBIT OR CREDIT
An overdraft is a kind of credit that is applied to your current account. It enables you to make withdrawals or pay bills from your bank account even if there is no money in the account at the time.
It is essentially a financial institution’s extension of credit that is issued when a customer’s account balance hits zero, as explained above. Account-holders may continue to withdraw money from their accounts even when there are no funds in their accounts or when there aren’t enough funds in their accounts to cover the amount of their withdrawal.
read more about bank reconciliation
Bank Overdraft Journal Entry
- At The Agreement Date No journal entry is necessary while signing the overdraft arrangement with the bank. The bank overdraft arrangement is an off-balance sheet item. It only becomes a liability when the corporation uses it.
- At The Date Of Using Bank Overdraft An overdraft loan may be used to fund a company’s cash account, while a cash account can be used to fund the company’s overdraft loan.
- At The Period-end Adjusting Entry After utilizing the bank overdraft, the corporation must account for the interest paid and paid on the overdraft at period end.
- At The Payment Date Of Bank Overdraft The corporation may make the following journal entry when paying the bank overdraft plus interest:
read also about Balance sheet
What Is An Overdraft Credit Facility And How To Get It?
- Permits you to utilize or withdraw more money than you have in your account, up to the allowed limit.
- The line of credit is often granted based on account balances and collateralized by bank FDs, shares, and bonds.
- The sanctioned overdraft limit and interest rate will vary depending on the collateral asset.
- The overdraft operates like a loan. Money may be withdrawn whenever needed, and interest is only charged on the amount borrowed and the period it was borrowed.
- A bank overdraft may assist individuals or small companies with cash flow concerns, but the negative-sum must be returned within a month.
