Bank Overdraft

From Financial Literacy Wiki

Bank Overdrafts allows one to borrow up to a predetermined amount, known as the credit limit, whenever the need arise. The overdraft account is activated when you write cheques to pay for goods purchased.

Bank overdrafts can be secured or unsecured. For secured ones, the borrower must pledge some collateral such as property, stocks, bonds and so on, with the bank. As secured overdraft represents low risk to the bank, they are generally cheaper than unsecured ones. But in the event of default or violation of terms in the agreement, the bank can seize the collateral and dispose of it to reduce the outstanding balance that you owe.

The credit limit given by banks would greatly be determined by your income, profession and earning potential of the collateral pledged. Some creditors may require a minimum monthly payment that is a fraction of the outstanding amount. And there are some banks that charge minimum interest payable regardless of the amount borrowed.

Interest rates on overdraft are often based on the prime rates of banks. For example, if your overdrafts are charged at +2%, then the interest you are paying will be 7% if the current prime rate is 5%. Take note that interest on overdrafts is computed daily on outstanding balance.