Overdraft

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"I warn you, Sir! The discourtesy of this bank is beyond all limits. One word more and I — I withdraw my overdraft!"

Cartoon from Punch Magazine Vol. 152, June 27, 1917

An overdraft occurs when withdrawals from a bank account exceed the available balance; i.e. over-drawings. This gives the account a negative balance and in effect means the account provider is offering credit.

If there is a prior agreement with the account provider for an overdraft facility, and the amount overdrawn is within this authorised overdraft, then interest is normally charged at the agreed rate. If the balance exceeds the agreed facility then fees may be charged and higher interest rate might apply.

[edit] Overdrafts in the UK

Banks in the UK often offer a basic overdraft facility, subject to a pre-arranged limit (known as an authorised overdraft limit). However, whether this is offered free of interest, subject to an average monthly balance figure or at the bank's overdraft lending rate varies from bank to bank and may differ according to the account product held.

When a customer exceeds their authorised overdraft limit, they go into unauthorised overdraft. Exceeding their authorised limit often results in the customer being charged one or more fees, together with a higher rate of lending on the amount by which they have exceeded their authorised overdraft limit (the unauthorised overdraft interest rate). The fees charged by banks can vary.

A customer may also incur a fee if they present an item which their issuing bank declines for reason of insufficient funds, that is, the bank elects not to permit the customer to go into unauthorised overdraft. Again, the level and nature of such fees varies widely between banks.

In 2006 the Office of Fair Trading issued a statement which concluded that credit card issuers were levying penalty charges (penalty charges - also know as liquidated damages clauses - are void in UK contract law unless they represent a genuine pre-estimate of the cost of a breach of contract) when customers exceeded their maximum spend limit and / or made late payments to their accounts. In the statement, the OFT recommended that credit card issuers set such fees at a maximum of 12 UK pounds [1].

In the OFT's statement, the OFT indicated that it thought the fees charged by credit card issuers were analogous to unauthorised overdraft fees charged by banks. Many customers who have incurred unauthorised overdraft fees have used this statement as a springboard to sue their banks in order to recover the fees. It is currently thought that the England and Wales county courts are flooded with such claims [2]. Claimants tend frequently to be assisted by web sites such as the The Consumer Action Group. To date no bank has appeared in court to justify its unauthorised overdraft charging structure and many customers have recovered such charges in full [3]. Some banks have responded to such actions by closing customer accounts, on the basis that those accounts have not been operated within the terms and conditions [4] which the customer consented to when the account was opened.