What is a bank overdraft?

If you have a cheque account, you may be offered an overdraft by the bank, either when you open the account, or later, when your income exceeds the threshold for an overdraft and your income and expenditure are established.

An overdraft is a line of credit typically linked to the account into which your monthly income is paid. It comes into play when your available funds run out and you need a temporary safety net to pay a bill, cover your debit orders, or fund spending you can’t put off until you have the money.

The value of an overdraft is that once you have applied for the facility, it kicks in automatically when your expenditure exceeds the funds you have available – you don’t need to apply for the credit at the time when you need it.

You also don’t need to take out a larger loan than you need. Within the limit of your overdraft, you can use as little or as much as you wish, when you need it.

In other words, by prior agreement with the bank, and proportional to your income and expenditure patterns, you have a credit ready and waiting for emergencies.

The cost of an overdraft

For the privilege of having an overdraft, you will pay:

• A once-off fee when the overdraft is set up;
• A monthly fee for having the facility on standby every month; and
• A pre-arranged rate of interest on the amount that you borrow.

The maximum fees you can be charged are regulated in terms of the National Credit Act. Read more: What does credit cost?

The annual interest rate that applies to the overdraft depends on how risky the bank regards you as a lender, and can be anywhere between the prime interest rate + 1.5% (prime being the minimum interest rate that banks charge their customers) and the maximum allowed by the National Credit Act: prime plus 10.5% or the repurchase rate (repo rate) plus 14%.

For example, assume you have a R15 000 overdraft facility at an annual interest rate of 15% and you use R8 000 of it to pay school fees at the beginning of the year. You will pay R100 in interest a month for each month the amount remains outstanding. That could be R1 200 if the amount remains outstanding for the year. That is over and above the monthly fee of R69.

You will also be encouraged to take out credit life insurance on an overdraft, as you would on a personal loan, so that your debt can be repaid should anything happen to you that prevents you from paying the money back.

Overdrafts are very convenient, but they are not a cheap source of money. If you set up an overdraft on your cheque account today and keep it as a safety net for 10 years (without using it and without fee increases), you could spend as much as R9 487.50 (including the initiation cost) just for the benefit of having a safety net.

Interest rates on overdrafts are calculated on a case-by-case basis, but the interest can be higher than rates you pay on a personal loan because of the exceptional convenience of overdrafts, the fact that the loan amounts are usually much smaller than personal loans, and there is no fixed period for repayment – although the expectation is that this is a short-term loan option. 

The pros and cons of an overdraft

The pros:

• Once you have set up an overdraft facility, you don’t have to apply for credit every time you need it. An overdraft is at your disposal at all times, whether or not you ever choose to use it, and is triggered automatically when you spend more than you have in your account.
  
  
• An overdraft is an example of revolving credit: the credit is renewed automatically every time you pay it off.
  
  
• It gives you the security of knowing you have a little extra in the bank in case of emergencies, so that you don’t risk missing debit order deadlines, and incur extra fees, or get a black mark on your credit record.
  
  
• You pay interest only on the amount of the overdraft that you spend.
  
  
• You can’t miss a payment because the overdraft is just a negative balance in your account that is reversed whenever money goes into your account. If you don’t receive enough during the course of the month to cover your normal expenses PLUS the overdraft amount, you remain in overdraft into the next month.
  
  
• There is no repayment term as there is with a personal loan, so you can pay back the overdraft at any time - bearing in mind that you will be paying interest – possibly at a higher rate than you could have received on a personal loan – on the money every month until you do pay it back.
  
  
• You can’t exceed your credit limit and keeping track of your borrowing couldn’t be simpler, since it is reflected on every bank statement.
  
  

The cons:   

• Overdrafts are easy money, but not cheap money. They give you a chance to overspend every month, as long as you have overdraft funds available, and it’s all too easy to overlook the cumulative expense of keeping an overdraft running. A personal loan, on the other hand, has an end date, after which you have to apply for another one.
  
  
• Relying on your overdraft too much, and/or exceeding your overdraft limit could affect your credit record. The extent of your indebtedness is taken into account by lenders, even if you are able to avoid exceeding your limit, and overdrawing on your account or your overdraft is regarded by creditors as a sure sign of poor money management.
  
  
• Overdrafts, with their high interest rates, are designed for short-term borrowing, not for the kinds of loans that pay for a holiday or build a new room on your house. Those projects are better suited to personal loans, which cover the exact cost, charge lower rates and have a firm repayment date.

Where can I get an overdraft?

Most of the major banks offer overdraft facilities on transactional accounts - the cheque or current accounts used for everyday expenses, into which your income is paid.

You can apply for an overdraft, or for an increase in the limit of an existing overdraft, through internet banking, via the banking app, in a branch or by calling the call centre.