Overdraft

An overdraft is short-term borrowing that lets the holder of a current account (a checking account in the US) spend more money than the account holds, taking the balance below zero. The bank pays the cheque, card payment or direct debit anyway and treats the shortfall as a loan that the customer repays as soon as money comes back in.

Overdrafts are a revolving form of credit: the customer can borrow, repay and borrow again up to a limit, with no fixed repayment schedule. They are offered to both individuals and businesses, for whom an overdraft is a common way to cover gaps in cash flow. How they are priced varies sharply by country, and in recent years they have been a target for regulators worried about high charges on customers with little money.

An overdraft is like a running tab at a local shop. If you are short one week, the shopkeeper lets you take what you need and writes it in the book. When you get paid, you settle up. The shop does this because it knows you, and it usually agrees in advance how much it will let you owe.

A bank overdraft works the same way, except the bank charges for the favour. If you agreed the limit beforehand, that is an arranged overdraft. If you go further than the bank agreed, or had no agreement at all, the bank may still let the payment through, or it may turn it down. Either way, money borrowed this way is one of the dearest kinds of credit, so it suits a few days, not months.

• Arranged (authorised) overdraft. The customer and bank agree a limit in advance, often after a credit check. Borrowing within it costs interest at the agreed rate and does not count as a missed payment.
• Unarranged (unauthorised) overdraft. The account goes below zero without an agreement, or beyond the agreed limit. The bank may pay the item and charge for it, or refuse it, in which case the payment bounces for non-sufficient funds (NSF).

Banks can usually reduce or withdraw an overdraft at short notice, since it is repayable on demand. A customer who stays overdrawn for long periods may be offered a cheaper structured personal loan instead. Persistent use is also visible to a credit bureau and can affect a credit score.

Most banks charge interest daily on the amount overdrawn, using an annual rate divided by the days in the year, and collect it monthly. A simple version is:

• $B$ is the overdrawn balance.
• $r$ is the annual interest rate, as a decimal.
• $d$ is the number of days the account stays overdrawn.

Worked example: an account is overdrawn by 500 for 10 days at an annual rate of 36%. The interest is $500 \times \frac{0.36}{365} \times 10 \approx 4.93$. In practice the balance changes daily, so the bank adds up each day's charge. Some banks also offer a small interest-free buffer, and the cost of borrowing for a whole year is shown as an Annual Percentage Rate (APR).

In June 2019 the Financial Conduct Authority (FCA) published Policy Statement PS19/16 after its high-cost credit review, and the pricing rules took effect on 6 April 2020. Before then, many UK banks charged daily or monthly fees for overdrafts, and unarranged overdrafts could cost far more than payday loans. The new rules require:

• A single annual interest rate for overdraft borrowing, with no fixed daily or monthly fees and no fee for simply having the facility.
• Unarranged overdrafts priced no higher than arranged ones.
• Prices advertised as an APR, with the cost also shown in pounds and pence.

Fees for refusing a payment because of insufficient funds are still allowed. When the rules began, many large banks set a single rate of around 40% a year, which lowered costs for heavy unarranged users but raised them for some customers who had used small arranged overdrafts. The FCA also introduced rules on helping customers who use their overdraft repeatedly.

In the United States, overdraft coverage has mostly been charged as a flat fee per item rather than as interest, historically about 35 dollars at large banks. Under Regulation E, banks have needed customers to opt in since 2010 before charging overdraft fees on ATM withdrawals and one-off debit-card purchases; cheques and recurring payments are not covered by that opt-in. In December 2024 the Consumer Financial Protection Bureau finalised a rule for banks and credit unions with more than 10 billion dollars in assets, which would have capped overdraft fees at 5 dollars, at cost, or treated larger fees as credit under lending law. Congress overturned it under the Congressional Review Act, and the resolution was signed on 9 May 2025, before the rule took effect. As of 2026 there is no federal cap, although several large banks have cut or dropped overdraft fees on their own since 2021. Overdrafts and bank charges remain a key part of how US banks earn fee income from a demand deposit account (DDA), alongside fees such as a dormancy fee.

• Financial Conduct Authority: PS19/16 High-Cost Credit Review: Overdraft policy statement
• Consumer Financial Protection Bureau