What is an overdraft? How does it work & is it worth it?

Ever swipe your card only to have the transaction decline? 

We’ve all been there.

Besides the embarrassment, this experience also comes with insufficient fund charges—fun.

Having an overdraft can solve this problem—here’s what you need to know.

 

What is an overdraft?

An overdraft is a type of loan arrangement. Banks offer overdrafts to account holders to let them withdraw or use more money than they have in the account. Whenever there isn’t enough money for a transaction or withdrawal, the bank automatically lends the necessary amount to cover the balance. The account holder then owes the bank plus interest and fees.

Overdrafts can be convenient. Just remember that fees and costs add up.

Here’s how it works.

 

 

How does an overdraft work?

An overdraft is essentially a short-term loan that allows a bank account holder to ‘overdraw’ their account. It allows individuals to spend or withdraw more money than they have in the account at the time. Letting the account go into a negative balance. With set limits, fees, and interest. Typically, the next bank deposit automatically repays the negative balance.

Here’s an example to illustrate how an overdraft works:

• Current account balance: R500
• Bill to be paid: R1,000
• Overdraft limit: R2,000

 

The account holder can pay the bill of R1,000 even though you only have R500 in their account. This is what it looks like after they pay the bill:

R500 current account balance – R1,000 bill = -R500 new account balance

Then, when there’s a deposit of R3,000, it will automatically go towards repaying the overdraft:

-R500 new account balance + R3,000 salary = R2,500 remaining balance after the deposit

It’s a convenient way to avoid missing payments or bounced transactions. But remember, it comes at a cost…

Let’s take a look at the fees.

 

Overdraft fees

An overdraft can be useful, but it isn’t free. Different banks have different costs and fee structures. Plus, the account holder’s credit score plays a part. However, this list should give you a good idea of what you might expect.

Common overdraft fees:

• Initiation fee: Some banks charge a one-time fee when you set up the overdraft. This could be as low as R50 or as high as R1,200+.
• Overdraft charge: Charged every time a transaction exceeds your available balance. Sometimes, ranging from R50 to R200 per transaction.
• Monthly service fee: Some banks charge a monthly fee for maintaining the overdraft facility, which can range from R20 to R100 per month.
• Daily fee: Some banks charge a daily fee instead of a monthly fee. This gets charged each day the account is overdrawn and could cost between R10 to R60 per day depending on the bank.
• Interest charges: Usually calculated daily on the amount overdrawn until the balance is positive.  Which, be as high as 17% per annum and could be higher. 

 

The best way to find out about your bank’s overdraft fees is by checking their website or phoning someone at the bank.

Now, let’s suppose you want to get an overdraft for your account…. How would you do it? We’ll tell you. 

 

 

How to qualify for an overdraft

Applicants need to meet specific criteria to qualify for an overdraft. Most banks want to see a steady income and a good banking history. Here’s what they’ll typically look at…

General qualifying criteria:

• Income: A minimum monthly income, such as R2,000 or R8,000.
• Account: A qualifying bank account that regularly receives a salary or other income.
• Identification: A valid South African ID card or another acceptable identification document.
• Credit history: The bank will check the applicant’s credit history to see whether they pay bills and other debt on time to make sure they have a good credit score.

 

In some cases, applicants may also need to provide additional documents, such as:

• Payslips or a letter from their employer: To verify income.
• Bank statements: To show account activity.
• Passport and work permit: If the applicant isn’t a South African citizen.

 

⭐ Related content: The credit score you need to qualify for a credit card

 

Next, let’s go over the application and approval process.

 

Overdraft approval process

The overdraft approval process varies by bank but generally involves an application and the submission of documents:

Overdraft applications steps:

1. Apply with a bank: Apply for an overdraft through the bank. Either online, by phone, or in person.
2. Gather and submit documentation: Provide all necessary documents like proof of income, bank statements, and ID.
3. The bank does a credit check: The bank checks credit history to assess risk and determine the fees.
4. Get an approval decision: The bank either approves or denies the overdraft and presents the terms.
5. Sign the agreement: If approved, all that’s left to do is sign the agreement and accept the terms, fees, interest rates, and repayment rules.

 

⭐ Related content: How the National Credit Act protects South African consumers

 

In summary

So an overdraft is there to help you manage short-term cash needs. But overdrafts aren’t free. It’s important to understand the costs so you can use it wisely.

If you think you’ll benefit from adding an overdraft to your account, by all means, go ahead. Follow the approval process and take care of it.

Maybe, you don’t want to add something that could cost more money. That’s perfect, too. Do what works for you. And if you can manage without an overdraft—more power to you.

If you want to talk to someone about managing your debt, we can help. Try our online assessment at My Debt Hero to see if you qualify to reduce your debt.