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What you should consider before taking a bank overdraft

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By Adaeze Okechukwu
A  BANK overdraft  is a temporary loan banks give  to individual and corporate account holders  that enable them withdraw funds above the balance available in the account. Thus,  an overdraft allows the individual to continue withdrawing money even if the account has no funds in it or not enough to cover the withdrawal.

However, there is usually a limit on the amount that can be overdrawn from the account. The  overdraft  limit is usually set by the bank  based on the amount of  working capital (the cash available for the company’s day-to-day operations) and credit worthiness (the ability of the borrower to honour the agreed debt obligation) of the borrower.

It is worth noting that the borrower is charged an interest  based on the amount overdrawn and the period of time overdrawn.

When do you need a bank overdraft?

An overdraft can be the solution when  the bills are due,  money is tight,  and  you need some extra cash, but payday hasn’t come around yet. They come in handy when you need to proactively manage these common cash flow problems.

Equally, companies obtain an overdraft to meet their ultra-short term cash shortage.  It serves as a form of working capital finance to finance a company’s day to day operational and unplanned expenses.

Meanwhile, employing a bank overdraft has its advantages and disadvantages. It is imperative to know them  in order to use it effectively.

How to apply for a bank overdraft

With most banks, it is straight forward to get a bank overdraft.

Step 1: Complete a Consumer Loan Application form which you may download online or pick up from closest branch to you.

Step 2:  Submit your application to the Customer Service Officer in your branch.

More often than not, banks have criteria customers must meet to grant them eligibility to access overdrafts. Some banks specify  income range of applicant, age range of applicant, type of account held by applicant- usually current or corporate account, tenure – usually in days.

Advantages

An overdraft allows you to access extra funds through your  current account up to an approved overdraft limit.  Hence, you can change the amount you borrow, as long as, it is within the limit.  It is flexible – you only borrow what you need at the time.

Interest is only charged on the amount overdrawn  (when fees and charges are paid on time) and not on the limit of the overdraft.

Overdrafts don’t have a set repayment schedule, thus, allowing you to decide when you want to make a repayment. For example, you can repay your overdraft, when your salary is credited to your account.

Availing bank overdraft facility is quick and hassle free -there is less documentation. Whereas, getting a bank loan can be a tedious task, as you are required to submit numerous documents.

Disadvantages

Overdraft facility comes with an interest charge which is much more than that of a loan. This, in turn, makes them expensive and the borrower is charged high interest rates if he goes over the agreed overdraft limit.

Overdraft undergoes regular revisit by the bank. The bank can change or withdraw the limit at any time.  The withdrawal of limit may happen when the borrower’s  financials represent poor performance; hence, the facility may be withdrawn when the borrower needs it the most. Moreover, the bank  has the right to ask for repayment of its overdraft at any time.

Routine funding activity

A bank can cancel the overdraft if you fail to meet their terms and conditions let alone repaying their money. Some  bank overdraft  facilities may be secured against collateral like shares, life insurance policies etc. The company may run a risk of those assets being seized if it fails to meet repayments.

Tips: You should  bear in mind that bank overdraft comes with a high cost and should be used as a stop-gap management of funds or as an emergency activity rather than a routine funding activity.  Advisably, only temporary working capital should be financed by  bank overdraft. Permanent working capital should be financed with  long term loans having lower interest rates.

You should also carefully consider the overdraft limit you apply for to avoid overspending. It is better you overdraft when you need a small amount, for a short duration and when you expect the amount shortly.

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