Definition of Overdraft

An overdraft is a banking service that allows account holders to withdraw money that exceeds the available balance in their current account. This term is widely used in both Arabic and international banking systems and provides customers with short-term financial flexibility.

How Overdrafts Work

When a customer makes a withdrawal or payment that exceeds their available balance, the bank provides the shortfall as an immediate short-term loan. This service prevents the rejection of important financial transactions such as bill payments or checks, protecting customers from financial embarrassment and additional fees associated with bounced checks.

This service requires prior approval from the bank, which evaluates the customer's financial situation and credit history before approving the overdraft facility. The maximum overdraft limit is determined based on the customer's income and relationship with the bank.

Types of Overdrafts

Overdraft services are divided into two main types, which differ in terms of arrangement, cost, and flexibility available to the customer. Understanding the difference between these two types is essential for choosing the most suitable option based on your financial needs:

Authorized Overdraft

This type requires a prior agreement with the bank, where the maximum overdraft limit and terms and conditions related to the service are determined. It features relatively lower interest rates and fees, providing customers with planned financial flexibility.

Unauthorized Overdraft

This occurs when a customer exceeds their balance without prior arrangement with the bank. This type carries much higher fees and interest rates and is considered less preferable from a financial perspective.

Fees and Interest

Banks charge fees and interest on overdraft amounts, which vary depending on the account type and bank. These costs include:

• Fixed fees: A specific amount charged for each overdraft transaction
• Daily interest: A percentage calculated on the withdrawn amount daily
• Arrangement fees: The cost of setting up an authorized overdraft facility
• Excess limit fees: Additional penalties when exceeding the approved limit

Advantages of Overdrafts

This service provides several important benefits for customers, including financial flexibility in emergencies and temporary liquidity needs. It helps avoid rejection of important transactions such as rent payments or utility bills, and protects against bounced check fees that may be higher than overdraft fees.

It also contributes to building the customer's credit history when used responsibly and repaid on time, enhancing their relationship with the bank and opening opportunities to access other banking services.

Disadvantages and Risks of Overdrafts

Despite the benefits, there are important risks to consider. The high cost of interest and fees can accumulate quickly, especially if not repaid promptly. Excessive use can lead to a debt spiral, where customers become continuously dependent on this service.

Tips for Optimal Use

To avoid financial problems, it's advisable to monitor your balance regularly and use banking apps to receive instant notifications. You should establish a clear budget and avoid relying on overdrafts as an additional source of income. Quick repayment of withdrawn amounts reduces accumulated costs.

Banking Regulation and Oversight

Overdraft services are subject to central bank supervision, which sets standards and controls to protect consumers. Banks must provide full disclosure of all fees and terms and obtain explicit consent from customers before providing the service.

Difference Between Overdrafts and Other Loans

Overdrafts differ from traditional loans in their flexibility of use and repayment, where customers can use the available amount as needed without committing to withdraw the full amount. Interest is also calculated only on the amount actually used, not on the entire authorized limit.