An overdraft is basically the facility offered by a bank that allows the individuals to consistently withdraw money from their accounts even if there is no balance in the account. In other words, overdraft is an extension of credit to the individual from a bank or a lending institution during the times, an account reaches zero.
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Overdraft is really a good option available to individuals in order to raise their funds for a short term as the facility helps them in managing short-term financial needs.
Some Reasons Contributing to the Occurrence of Overdrafts
- ATM Overdraft
- Merchant Error
- Intentional Loan
- Electronic withdrawals that occur unexpectedly
- Not being able to maintain a reliable account register
The procedure involved in overdraft is same as taking other loans. For overdraft, an individual needs to offer the bank some collaterals that include his/her house, bonds, fixed deposits, shares, and insurance policies. The best part about overdraft facility is that bank or lending institutions don’t take much time to sanction overdraft against fixed deposits. Another important point to note is that banks usually prefer surrender value of life insurance policies while offering the overdraft.
Banks offer the overdraft facility by charging a fee and interest on the surplus amount, withdrawn for the duration of time. As overdraft offers the number of advantages to the individuals, the bank overdrafts assist the businesses whose cash flows in an out several times in a month. Apart from this, overdrafts allow the businesses to manage cash flow gaps occurring due to a mismatch in time. Overdrafts facility also helps in maintaining a good payment history of the business.
As business overdrafts are usually offered at a specific cost, there are some costs that an individual needs to consider. Listed below are the 6 Direct Costs that an individual needs to consider if he/she is availing overdrafts facility.
- Interest
- Arrangement fees
- Professional advice
- Maintenance charges
- Covenant compliance costs
- Unauthorized borrowing fees
Advantages of Bank Overdrafts
- As this is usually that cash flows move in and out the business a number of times during a month, overdrafts have a great role to play in a business. The overdrafts facility enables the business owner to manage cash flow gaps that sometimes arise due to timing mismatch. Thus it efficiently handles timing mismatch of flow of funds.
- Overdrafts ensure that that timely payment is being made to each one who is involved in any sense in the business. Hence, there is no chance of late payments which further reduces the risk of penalties due to the fact that payments would be made even if there is no balance in the account.
- Overdrafts reduce the need for managing paperwork facility, unlike long-term loans which require a lot of paperwork.
- Last but not the least, an individual also gets the advantage in interest cost as the interest is calculated only on the number of funds utilized, thus great savings are made in the interest cost as compared to an ordinary loan taken on a fixed interest rate.