Overdraft Advantages and Disadvantages

Overdraft advantages and disadvantages are something you should be fully aware of before gaining access to one. Money issues can be difficult to handle, and overdrafts can be a temptation that not everyone can handle.

In fact, if you activate an overdraft on your bank account, you may find yourself living in it if you don’t have clear plans on how to repay it. This is why money management skills are essential before you apply for one, as overdraft disadvantages can lead to stressful money situations.

If you’re looking at getting an overdraft, make sure you’re educated before signing the dotted line. The MoneyBright experts have explained everything you need to know, including:

• What is an overdraft?
• How does an overdraft work?
• What are the advantages of an overdraft?
• What are the disadvantages of an overdraft?
• How do you pay back an overdraft?
• Should you apply for an overdraft?

What Is An Overdraft?

An overdraft is an amount of money that you have access to that isn’t part of your overall balance and belongs to the bank. It is usually only accessible once you have spent all of the money that is in your account and once you put money back into the account, the overdraft will be paid off.

How Does An Overdraft Work?

There are two different types of overdrafts, authorised and unauthorised overdrafts. Either can be attached to any valid bank account that offers an overdraft service, but they function in very different ways.

The core function of an overdraft works is to allow you to spend money when your bank balance is at zero. An authorised overdraft is an overdraft that is an agreed-upon amount of money that you have full access to and is often interest-free (or low in fees).

An unauthorised overdraft is an overdraft that hasn’t been pre-planned with you and your banking provider. This type of overdraft will allow you to go into it and use the money to pay for things, however, the interest rates and fees are often higher, and it can affect your credit score.

What Are The Advantages Of An Overdraft?

Whilst overdrafts shouldn’t be relied upon as an everyday occurrence, they are an incredibly useful tool when you need a backup source of money. For example, if you have an emergency that you need to pay for but your payslip doesn’t come in for a week, you can access your overdraft and pay it back the next payday.

This flexibility is a great advantage of overdrafts, as you can use them as and when you need them without having to use the full overdraft limit.

Another overdraft advantage is the lack of payment plans. Most overdrafts don’t have a repayment schedule or a high rate of interest, meaning you can use what you need and pay it back when you can without the same worry that comes with other short-term loans or credit cards. However, before using any overdraft, make sure you fully understand the terms and conditions to avoid any nasty surprises.

What Are The Disadvantages Of An Overdraft?

Whilst overdrafts are a very accessible and convenient way of borrowing money as a young person, overdraft disadvantages are still important to take note of before using them.

They are a type of borrowing, and as such, you can expect charges to be applied. No money is free money, and the bank usually acts to make a profit from the money they lend out. These charges can quickly spiral into huge costs, especially if you are not using an overdraft within its arranged limits or you’re accessing an unauthorised overdraft.

The interest rates can also be applied, and as your overdraft is part of your bank account, you won’t be able to negotiate these or find better rates elsewhere.

Another disadvantage of overdrafts includes the financial dependency that can be bred from having access to money that doesn’t feel restricted. If you haven’t got much financial restraint or you feel as though you could be more financially literate, it may be best if you hold off on gaming access to an overdraft.

It is easy to get carried away by the money being available to you, which can lead to you being in your overdraft for a long time, and losing any financial stability and independence as a result.

Another overdraft disadvantage is the lack of stability in the lending. Whilst overdraft advantages include a lack of forms to fill in and quick and easy access, the bank has the right to remove it just as quickly. This can leave you in the dust, having to repay huge sums of money (depending on how much you’ve used) at the drop of a hat.

How Do You Pay Back An Overdraft?

You can pay an overdraft off in any way that suits you best. Luckily, there are rarely clauses that dictate when and how much you should pay back, so you don’t have the same time pressure.

Any amount of money you deposit into a bank account that has an active overdraft will be used to pay it back. However, if you have a large amount to pay back and you’re struggling with your budget, you can always set up another account.

This can help you manage savings, overdraft payments and the day-to-day cash that you need to live and pay for things. Some prefer to chip away at what they owe with smaller payments here and there, whilst others like to save separately and pay it all off in one chunk. Whichever you choose, remember to take into account any interest rates and charges that apply.

Should You Apply For An Overdraft?

You should apply for an overdraft if you intend to use it in the way it is designed to be used.

The advantages and disadvantages of overdrafts will depend on the way you handle your money, but anyone can fall into the habit of living out of their overdraft. If you intend to use it in the short term and have clear plans on how to pay it off, you should consider applying for an overdraft.

However, if you’re the type of person who struggles to stay within a budget or has a lot of random outgoings that are hard to track, you may need to reconsider. Regardless, it’s important to speak with your bank and take any professional, independent advice before you sign up for an overdraft.

MoneyBright Is Here To Help!

There are many ways to make the most out of an overdraft, and more ways to manage your money when you use it. It’s important to stay educated on financial matters if you’re going to begin borrowing money, as it can quickly become overwhelming if things get out of control.

Rely on MoneyBright to give you the information you need to be up to date, read more of our personal finance and money-saving articles for some inspiration, and check out our TikTok for quick content.