What is an Overdraft Interest?

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When it comes to finances, you should always prepare for the unexpected. Emergencies can arise at any time, and without warning, you could need money to pay for a new car, a new furnace, a new refrigerator – the list goes on and on.

And when emergencies like these arise, it’s important that you have the funds available to you. Starting your own savings account for emergencies is the best thing you can do, but when money is tight, there are other options available to you. More specifically, we’re talking about overdrafts. 

What is an Overdraft?

An overdraft is a type of protection that financial institutions offer. If you spend more money than what is in your bank account, overdraft protection can help you from sinking up to your neck in debt from interest fees. In this way, it helps you to manage your finances. 

You can think of an overdraft like a small loan. It can help you to avoid declined transactions in stores, late charges on pre-authorized payments, and fees associated with non-sufficient funds. 

It works like this; if you make a transaction but don’t have sufficient funds in your bank account to pay for it, an overdraft allows you to go into a negative balance. You can then pay off this balance the next time you add money to your account.

With overdraft protection, you can safely go into overdraft without worrying about fees. If you don’t have an overdraft, you will be charged fees and interest each time your account goes into the negative. 

What is Overdraft Interest? 

Overdraft interest, then, is the interest charged on the money withdrawn in overdraft. Even if you have overdraft protection, you will be charged interest on your overdraft if it’s not paid back immediately. Overdraft rates will vary depending on which bank you are with but usually sit somewhere around 21% per annum.  

The amount owing on your overdraft interest depends on your annual interest rate, as well your overdraft balance, and how long you’ve been on overdraft. 

You can calculate your overdraft interest with the following calculation:

Overdraft interest = overdraft balance x annual interest rate + 365 (days in a year) x number of days you’ve been in overdraft. 

How Do I Make an Overdraft Payment?

When you make a payment on a loan like a credit card, you choose how much you want to pay and when. But overdrafts work a little differently. Instead of choosing how much you want to pay, your overdraft is paid down each time you deposit money into your bank account.

To help you understand better, let’s use an example. Let’s say you are overdraft $150. That means that you are -$150 in your bank account and owe that money to your financial institution.

Now let’s say you deposit $150 into your bank. This will pay your overdraft, and you will now have a balance of $0. If you were to deposit more, let’s say $300, you would now have a positive balance of $150 in your bank ($300 deposited – $150 owing). 

What happens if I don’t have Overdraft Protection?

If you don’t have overdraft protection on your account, you may be denied when making transactions. Not only can this be embarrassing, but it may mean that you can’t buy your groceries or other necessities for the week. It may also mean that your bill payments may be denied, which can put you in debt and affect your credit.

In some cases, your financial institution may still allow you to go into overdraft even without overdraft protection. If this happens, you will be charged a hefty fee. 

If this is your first time going into overdraft or there are special circumstances as to why this happened, your institution may be kind enough to cover the fees for you. But if this happens regularly, fees can add up quickly, and it would be wise for you to invest in overdraft protection. 

In conclusion, overdraft protection can provide you with extra funds if you are running low or need some extra help. Overdraft interest is the interest associated with going into an overdraft. These fees can be high, so it’s important that you avoid going into overdraft whenever possible and pay it off as soon as possible if you do. 

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Kareena Maya

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Kareena Maya is a freelance writer focused on the personal finance and travel spaces. He frequently writes about credit cards, banking, student loans, insurance, travel rewards and more. His work has been featured in publications such as Forbes Advisor, Bankrate, Credit Karma, Finance Buzz, The Ascent and Student Loan Planner.

Kareena Maya is a freelance writer focused on the personal finance and travel spaces. He frequently writes about credit cards, banking, student loans, insurance, travel rewards and more. His work has been featured in publications such as Forbes Advisor, Bankrate, Credit Karma, Finance Buzz, The Ascent and Student Loan Planner.