What is an Overdraft Facility?
An overdraft facility is a formal arrangement with a bank that allows an account holder to draw on funds in excess of the amount on deposit. This type of financing is most commonly used by businesses as a way of making their working capital more flexible, although it can also be available to individuals. Banks that offer this service typically have a number of expectations from customers who use it, and it is important for customers to be aware of these expectations before entering an agreement.
The idea behind overdraft facility agreements is that sometimes one needs a bit more money than is available on deposit to deal with various expenses. For example, a business that is always slow in March and April might need help to make payroll and keep current with all accounts and creditors. Another business might need to make a big one-time expense that exceeds the funds on deposit.
With an overdraft agreement, the company can repay the funds at its convenience. The bank may charge an overdraft fee for accessing the money, however, and the interest rate can be higher than that for other types of loans. The bank also has the right to demand repayment in full. Balancing an overdraft facility wisely can free up capital and make people more stable financially, but unwise use can lead people into a spiral of debt that may be difficult to escape.
The amount available to the company or individual is also limited; people are not allowed to continually take money out and not repay it. The amount of the overdraft is usually pegged to account history and financial information, with the goal of ensuring that people do not end up borrowing more than they can realistically repay. The agreed limit can be negotiated with the bank, and some financial institutions are willing to reevaluate that amount if customers feel that their circumstances have changed.
Overdraft facilities provide flexibility and a bit of a buffer that can be used to ride through a period of hard times. Other lending instruments may be more practical, however, and it is a good idea for customers to talk about options for accessing lines of credit and loans with a bank staffer or financial adviser before making any firm choices. It is important to avoid making a financial choice that would be problematic later in the hurry to access funds to deal with a current problem.
My first year of college, I had huge trouble with my bank and its form of overdraft facility. I use online banking, and the information on the website had not been clear enough about how much money I had, so I ended up overdrafting several times- in the end, they were charging me 30 dollars each for overdrafts of less than ten dollars. I ended up several hundred short, and it was more the bank's fault than the fault of anyone else. I switched banks and became paranoid about my account's bottom line- I haven't overdrawn money since, but if I did, I'm not sure if I would trust this new bank to treat me fairly any more tan the last did.
When you choose a new bank, make sure you understand what they mean in their overdraft policies. A lot of banks throw around terms like "overdraft security" and "overdraft protection", but it means very little when you actually end up overdrafting your account. Furthermore, these services often have high fees, so unless you are really worried about taking out too much money, it might be cheaper to risk the occasional overdraft, depending on the bank's fee.
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