Spending more money than you have in your bank account results in an overdraft.
In most cases, the bank will pay for the transaction but will charge an overdraft fee. Some banks impose a charge for each day that the bank account has a negative balance. Account holders should replenish their accounts to avoid accumulating large overdraft charges.
If an overdraft is resolved in a timely manner, it will not affect the credit rating of the account holder. However, failure to repay the overdraft can have a negative effect on credit.
UK bank account holders have the ability to pre-authorize a certain level of overdrafts. For consumers who tend to spend more than they have in their bank accounts, this is a smart idea.
Each bank handles its basic overdraft feature differently, with some allowing interest-free overdrafts to a certain limit, while others use an average monthly balance and some provide a separate lending rate. Guidelines for overdrafts also vary based on account type.
Overspending and ATM withdrawals are two situations that can result in an overdraft. Though interest may be charged for an authorized overdraft, the charges will be less than if the overdraft was unauthorized. Account holders with pre-authorized overdrafts should avoid exceeding the overdraft limit because this will incur a higher interest rate and other charges.
The bank will initially attempt to get an overdrafted account back into good standing. If the account holder takes action, his or her credit report will be unaffected because current account activity is not reported to credit reference agencies. If the account holder does not heed bank requests, the bank may turn the account over to a collection agency.
If this happens, the account will appear on the credit report of the account holder and remain there for up to six years. In addition, the credit score will decline.
The bank or collection agency may take the account holder to court and request issuance of a County Court Judgment. This will make it even more difficult for the account holder to get additional credit like an auto loan, credit card, or mortgage.
Mortgage lenders become uneasy as soon as the account enters collection status because they see it as a sign of financial mismanagement.
If the bank account ends up being closed by the bank, the former account holder may have difficulty being approved to open another account within a five-year period. Even worse, a bailiff may come to the home to take property and sell it to repay the overdraft. The home can even be put in jeopardy of being repossessed.
To prevent this from happening, bank account holders should avoid overdrafting their accounts. If the occasional overdraft occurs by mistake, the account holder should immediately repay it in full. If this is not possible, the individual should propose a repayment schedule to the bank. The last resort is to explore a debt management solution like a debt consolidation loan.