Borrowing and credit
What is an overdraft?
Quick definition: An overdraft is borrowing through a current account when payments take the account below zero or below the customer's own money.
At a glance
- It is a form of borrowing, not extra income.
- It may be arranged or unarranged.
- Interest and charges can apply under the account terms.
- Using an overdraft can affect financial checks and budgeting.
Explain it simply
An overdraft lets a current account go below zero, or lets you spend more than the money you have in the account. It is borrowing from the bank. If the bank agrees a limit in advance, it is an arranged overdraft. If you go overdrawn without agreement or past the limit, it may be unarranged. Overdrafts can be expensive, so they are usually best treated as short-term borrowing rather than normal spending money.
Student explanation
Overdrafts are linked to current accounts and can help cover short-term cash flow gaps. They are different from personal loans because borrowing is flexible and attached to account use. The main distinction is between arranged overdrafts, where the bank has agreed a limit, and unarranged overdrafts, where the account goes overdrawn without agreement or beyond the agreed limit. Students should compare overdraft costs carefully, understand alerts and avoid relying on overdrafts for ongoing living expenses.
Professional explanation
An overdraft is a credit facility or debit balance arising on a current account. Arranged overdrafts are agreed in advance with defined limits and pricing, while unarranged overdrafts arise when transactions exceed available funds or agreed limits. Overdraft management involves credit risk, affordability, conduct regulation, customer communications, alerts, collections, forbearance and reporting to credit reference agencies where applicable. Unlike a term loan, an overdraft is typically repayable on demand and fluctuates with account activity. It should be presented clearly as borrowing, including where available balance displays include unused overdraft capacity.
UK example
A worker has 20 pounds in their account and an arranged overdraft, then pays a 35 pound bill, leaving the account 15 pounds overdrawn.
Why it matters
Overdrafts can make payments possible in the short term, but misunderstanding them can lead to unexpected borrowing costs.
Common misunderstanding
An overdraft is not free spare money; it is borrowing and can be repayable under the account terms.