Overdraft

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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 found that the banks were exploiting penalty bank charges on credit cards and has suggested that banks restrict such penalty to a maximum of 12 UK pounds [1]. Penalty charges or liquidated damages are illegal in UK contract law unless they represent the real cost of a breach of contract incurred through an unauthorised overdraft level or bounced cheque. This ruling by the OFT has been extended by many customers to their personal bank accounts and currently the UK small claims court system is flooded with cases of customers reclaiming these ‘illegal’ penalties [2], often assisted by web sites such as the The Consumer Action Group. To date no bank has appeared in court to justify its penalty charges and most customers have recovered such charges in full [3]. However, at least one bank has responded to such actions by closing the customer's account, stating that the individual has clearly not accepted the terms and conditions [4].