Bank overdraft is a type of financial instrument that is provided to some customers by the bank in the form of an extended credit facility, which comes into effect once the main balance of the account reaches zero.
In other words, bank overdraft is an unsecured form of credit that is mainly used for covering short term cash requirements.
Banks offer a credit limit to the bank customers based on their relationship with the bank. The bank levies separate interest and charges towards non-maintenance of account. The interest rate for the overdraft facility may vary from bank to bank.
Also check: Banking and its Type
Features of Bank Overdraft
Following are the features of bank overdraft facility:
1. Banks offer overdraft facilities on a predetermined limit which differs from borrower to borrower.
2. In an overdraft account the withdrawal or deposit of an amount can be done anytime upto the specified limit.
3. The bank charges an interest on the overdraft amount which is calculated on a daily basis and is billed monthly to the borrowers account. There is an increase in interest if the borrower defaults in paying the amount.
4. Banks do not charge prepayment penalty on the borrowers in the event of loan repayment before the tenure. This is a feature that is different from other kinds of loans.
5. The system of EMI is not applicable in bank overdraft accounts. Borrowers can repay the amount by paying off different values each time.
6. There can be joint borrowers of an overdraft loan and both the applicants are equally responsible for repaying the borrowed amount.
Types of Bank Overdrafts
There are two types of bank overdraft accounts
1. Authorised Bank Overdraft: In this type of overdraft account there is arrangement made in advance between the account holder and the bank. Both the parties mutually agree on a limit which can be used for all the payments and a daily, monthly or yearly service fee that can vary from bank to bank.
2. Unauthorised Bank Overdraft: This type of overdraft occurs when the bank account holder has spent more than his available balance without prior authorisation or any such arrangement with the bank or if there was an arrangement done before but the limit of overdraft is exceeded.
Advantages of Bank Overdraft
Following are the advantages of bank overdraft:
1. Helps in managing the availability of cash for a business or an individual.
2. Helps in fulfilling urgent cash requirements.
3. Interest needs to be paid only on the amount that is utilised and not the total limit.
4. There is less amount of paperwork involved in availing bank overdraft.
5. There is no requirement of collateral.
Disadvantages of Bank Overdraft
Following are some of the disadvantages of the bank overdraft:
1. Higher interest rate charged for the loan facility availed.
2. It is offered only to the bank account holders.
3. The limit offered depends upon the financial position of the individual or business.
4. The interest rate is not fixed and changes frequently.
5. Is not an ideal option for long term financing.
This concludes our article on the topic of Bank Overdraft, which is an important topic in Business Studies for Class 11 Commerce students. For more such interesting articles, stay tuned to BYJU’S.
Frequently Asked Questions on Bank Overdraft
1. Is bank overdraft an asset or liability?
Bank overdraft is regarded as a current liability that is payable within the accounting period. It is shown on the liability side of a balance sheet.
2. Is bank overdraft a type of loan?
Bank overdraft can be regarded as a short term financing instrument which can be availed by a bank account holder with a bank. It is not purely a loan like the conventional loan types, for eg home loan, business loan, personal loan, etc.
3. Why is bank overdraft a liability?
Bank overdraft is considered a liability because it is an excess amount of money that is withdrawn from an account as compared to the amount deposited and that results in a negative account balance. The amount taken as overdraft needs to be repaid by the business, hence, it is considered as a liability.