How Overdraft Protection Really Works

Why Available Balance Surpasses Bank Account Balance

While standing in queue for the ATM, you might have heard a myriad of discussions. One such intriguing topic that I found people grappling with was the understanding of why their available balance was more than their actual bank account balance. This confusion is not uncommon and I, as an ex-banker, have addressed this question umpteen times.

Unravelling The Puzzle: Available Balance and Overdraft Limit

Imagine standing at the ATM, withdrawing some cash and your receipt shows an unexpected $500 “bonanza”. You might be tempted to think it’s a mistake. But, the reality could be different. This “available balance” might include the $500 overdraft limit that you have on your account, and you have the liberty to spend this $500 whenever you wish.

This entire concept of overdraft limits is often misunderstood as a surprising windfall, which is far from the truth. It is a product that if not used wisely, can transform into a debt that’s challenging to repay.

The Art of Cross-Selling: Offering Overdraft Protection While Opening a Bank Account

The process of opening a new bank account can provide a plethora of opportunities for the financial institution to cross-sell their other products. Overdraft protection is one such product that is logically offered to a client opening a new bank account, because it is essentially a loan attached to the account.

It’s crucial to remember that just because an offer has been made, it isn’t mandatory for you to accept. It’s completely up to you to ask questions, explore more about the products they are offering and then make your decision if you want to “buy” what they’re offering or not.

Unveiling Overdraft Limit or Overdraft Protection

Whether you have a poor credit score or are attempting to rebuild credit after bankruptcy, you might still qualify for overdraft protection.

Your overdraft limit is essentially a loan. Overdraft protection serves as a safety net in your bank account so that if you withdraw all the money, based on a preapproved limit, you can take out a bit extra. This facility can be attached to a chequing account as well as a savings account. Even those with poor credit scores or are trying to rebuild credit, often have a low overdraft limit on their account.

This additional available amount (which is your overdraft limit) signifies that you are borrowing money from the bank. Whenever you borrow money, you are liable to pay interest on what you borrow. This rule applies to overdraft protection as well as when you overdraw your bank account unintentionally.

The Costly Convenience: Fees and Interest When Using Your Overdraft

Utilizing your overdraft can turn out to be an expensive way to borrow a little extra. The annual interest rate is often set around 21 percent. If you surpass the overdraft limit, or overdraw your account (even due to service fees) without any limit, you may have to pay as much as $5.00 every time your account dips below zero.

Each bank and credit union have their own set of fees and charges, but generally, overdrawing your bank account costs more than charging the same amount on a credit card.

Overdraft Protection: A Protection or a Problem?

The risk associated with using overdraft protection is that it can lead to a continuous cycle of borrowing that’s extremely hard to break. For instance, if your bank account is negative by $500, and you’re paid $1000, your bank account balance only rises to nearly $500. It doesn’t quite reach $500 because you pay interest and fees first.

Then if you have $900 of bills to cover, you’re compelled to dip back into your overdraft, or rely on another form of credit, like a credit card or even a payday loan, to cover the $400+ deficit. Soon, you’re depending on your overdraft to make ends meet.

The role of your overdraft as a protection or a problem entirely depends on how you utilize it.

If you have added it to your bank account, ensure that you don’t perceive it as “free money.” Remember, it’s a loan and borrowing on demand by using overdraft is a service you pay for.

The Overdraft Effect: Why Your Available Balance is Higher Than Your Bank Account Balance

In case you have overdraft protection on your account, your available balance will surpass your bank account balance. However, it’s not necessary to spend your overdraft.

A more prudent money management strategy would be to strive towards saving some money in a separate bank account. Devise a realistic personal or household budget so that you can manage all of your routine and irregular expenses, as well as set money aside in savings to use for unforeseen expenses or emergencies.

Having cash in your savings account is the genuine protection you can rely on.

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