Overdraft: What is it and how to avoid it?

An overdraft is a financial service provided by banks that allows a customer to spend more money than they have in their account. Essentially, it is a short-term loan that a customer takes out from the bank when their account balance goes negative. An overdraft can be authorised (agreed in advance with the bank) or unauthorised (occurring automatically without prior agreement). The bank usually charges interest for using an overdraft and may charge additional fees for exceeding the limit.

The consequences of an overdraft can be varied and depend on the bank's terms and conditions and the frequency of overdraft use. The main consequences include:

• Interest rates: The bank charges interest on the overdraft amount. Interest rates can be quite high, resulting in an increase in the amount owed;
• Fees: Some banks charge additional fees for overdraft utilisation, especially if it has not been pre-arranged;
• Negative impact on credit rating: Frequent overdraft use or non-payment of arrears can have a negative impact on a customer's credit rating, making it difficult to obtain loans in the future;
• Restricted access to the account: If the limit is frequently or significantly exceeded, the bank may restrict access to the account or require immediate repayment of the debt;
• Loss of the bank's confidence: Regular use of overdrafts may reduce the bank's confidence in the customer, affecting the ability to obtain other financial services and products;
• Legal implications: In case of non-payment of the debt, the bank may take legal action to recover the debt, resulting in additional costs and stress for the customer.

What causes a technical overdraft?

Technical overdrafts arise due to temporary delays between the transaction record date and value date caused by the bank's internal processes and are usually excluded from fees and interest charges. Knowing how much money we have in our account is very important in order to properly manage liquidity and cope with upcoming expenses. And sometimes just a few days can play a cruel joke on us.

So, first of all, you need to know that every transaction in your account has two dates:

• The value date of the transaction, which in the case of credits and debits means the day the funds became available. In financial terms, it is the point in time at which an accounting entry begins or ends the accrual of interest;
• The transaction date or accounting date, which corresponds to the point in time when the entity makes the entry, although the funds, in the case of a credit memo, may not yet be available for use.

Generally, discrepancies between these two dates do not have serious consequences, as available funds are usually recognised in the case of payments. An estimated or technical overdraft occurs when we order a debit from our account in excess of available funds. The term "technical or estimated overdraft" refers to those short-term overdrafts whose sole cause is bank mechanics that generate a difference between the record date and the value date. Although such overdrafts should be excluded from the payment of fees, the rules do not prohibit the bank from charging you interest for this reason.

An example of a technical overdraft would be adjustments on an outstanding transaction. Imagine you withdraw money from an ATM but don't take it back and cancel the transaction. The bank will keep records until it realises the error: the value date must match the day of the transaction, even if the reporting date is later.

Keep in mind that, in practice, the overdrafts that are most often encountered are usually due to the internal features of the product itself, and the bank has the right to charge interest and a fee for opening an overdraft if this is stipulated in the agreement.

Let's look at an example

Joan is about to deposit a cheque from another bank into a branch of her bank so that it can be cashed. She needs the money immediately because she has to pay a supplier with this cheque. This transaction involves a number of technical difficulties. In particular, Joana's bank has to verify that the cheque writer has sufficient funds. After checking, it will transfer the amount to her account. If you pay the supplier on the same day you deposit the cheque, there will be an overdraft due to lack of funds.

In this case we need to look at the valuation and accounting dates, which will be different dates. Which one are we interested in for the purposes of availability of funds? The date of the transaction or when the funds are credited. The institution should explicitly alert you to the uncertainty of the finality of the credit until the payment is verified. Another example would be international transfers where, although the reporting date is when the funds are made, the funds will not be available until several days later.

What dates do the rules set? In addition to the internal valuation rules that each institution establishes and must publish, there are regulations that set maximum values for allowable delays depending on the transaction being executed. The Payment Services Regulation establishes that the value date of the credit to the beneficiary's payment account must be no later than the business day on which the amount of the payment transaction was credited to the account of the beneficiary's payment service provider. That is, if you make a transfer from your bank to another bank, the funds must reach the beneficiary no later than the end of the next business day. Transfers from the same bank are usually made on the same day. Remember that a business day does not include Saturdays and Sundays.

Conclusion

Understanding the different dates associated with banking transactions is key to managing your finances effectively. The difference between the transaction date and value date can affect the availability of funds and the occurrence of overdrafts, which in turn can affect your financial plans. Being aware of these aspects will help you avoid unexpected fees and interest, as well as help you plan your spending more accurately. When dealing with the bank, it is always worth clarifying the details and rules to avoid unpleasant surprises and manage your finances as efficiently as possible.