Bank overdrafts on personal accounts
An overdraft is created when a bank makes payments out of a current account in spite of the account holder not having sufficient funds in the account to meet the payment, either by arrangement with the bank or otherwise. Overdrafts can be created on current accounts only. It is the account holder’s responsibility to ensure that sufficient funds are available in the account at the time of issuing a cheque or other payment instructions. This can be in the form of a credit balance in favour of the customer or by prior arrangement with the bank to overdraw the account to make the payment.
Even if prior arrangements have not been made by the account holder the bank may for a good customer, make a payment/s by overdrawing the account expecting the customer to make good the funds. However, this will be done purely at the discretion of the bank. The bank will usually takes that decision based on past performance and standing of the customer.
There are three types of overdrafts.
A Permanent Overdraft is a credit facility granted by the bank to its customer to pay up to a specified amount beyond the balance available in a current account. It is always by prior arrangement. The bank will usually request for security usually a lien (blocking) a Time Deposit with the same bank. A deposit may be dispensed with for very good account holders. The rate of interest payable is pre-agreed and will not change until the next review.
Banks usually review such facilities after one year and the Interest rate applicable for the next period may change depending on the market rates. It is important to remember that the current account should have wide fluctuations balances instead of the balances being around the upper limit, in which case a loan may be the facility that should be requested instead of an overdraft.
A Temporary Overdraft is granted only for a very short period usually not exceeding one month. The bank may require evidence of source of funds to liquidate such overdraft prior to expiry. Temporary overdraft is an unsecured credit facility and therefore banks are very selective in granting such facilities. A letter of request for such facility stating the period for which it is required, the purpose for it is to be used and the source of repayment by the expiry date should be submitted to the bank well in advance giving them time to make their decision. The facility is granted purely at the discretion of the bank and it is not uncommon for banks to decline such requests.
Casual overdrafts are granted by banks without any prior arrangement, where the bank for its good customers, may honour cheques and other payment orders by overdrawing the customer’s current account expecting the customer to regularise the account without delay. It is a facility granted by the bank without even a letter of request and is totally unsecured and usually for a very short period. The account holder is obliged to make good the funds without delay.
Permanent Overdrafts always require proper documentation. An overdraft agreement, Promissory Note, a letter of set-off if secured by a deposit plus any other documents that may be required to secure the advance. The bank may sometimes require a guarantee from a suitable person in which case a Guarantee Bond signed by that person will also be required.
In the case of Temporary Overdrafts similar documentation may be required but if the amount requested is small and the period requested is very short the bank may require only a few simple documents.
In both cases if the overdraft is secured by a time deposit the bank will require deposit of original Time Deposit Receipt or if against funds available in a Savings Account, by blocking of funds in such deposit
Interest rates and fees
In the case of a Permanent Overdraft an agreed rate of interest will be applicable and is usually about one percent higher than the rate for a loan to be granted for a similar purpose. The rate of interest on a Temporary Overdraft is usually not pre-agreed and is higher than that for a Permanent Overdraft and is the same as for a Casual Overdraft. The rate of interest applied on a Casual Overdraft is the highest rate for an advance granted by a bank. Interest is debited to the same account monthly calculated on balances outstanding as at the end of each day. Therefore arrangements should be made to provide sufficient funds in the account to meet the interest debits as well.
Banks usually levy a documentation fee for setting up a Permanent or Temporary Overdraft. In addition, where applicable, Government Stamp Duty may have to be paid on certain types of security documents that are taken by the bank.
(Please note that this is based on current practices and may vary from bank to bank)