Debit cards are often seen as a way to avoid the debt traps that credit cards can sometimes lead card users in to.  And by and large this is true.  However there are hidden dangers that debit card users should be aware of. Overdrafts can be, if managed well, a very useful thing for a debit card user.  Combined with a debit card they can help manage your cashflow and finances more efficiently.  However they should be managed very carefully.

An overdraft account is a type of short-term loan that allows you to withdraw more money than you have in your bank account, up to a certain limit. It is usually linked to your everyday transaction account and can be accessed with your debit card, online banking, or at an ATM. You only pay interest on the amount you use, plus a monthly fee if you use the overdraft. Some banks may also charge a setup fee or an overdraft limit fee.

You’ll need to apply with your brank and meet certain eligibility criteria. This could be things like having a good credit record and a regular income. The overdraft limit will depend on your financial situation and the bank’s assessment. Some of the major banks that offer overdraft accounts in Australia are Commonwealth Bank, ANZ, Westpac, and NAB.

Benefits of an overdraft account

Depending on your financial circumstances an overdraft facility on your debit card could provide you with:

• – Access to emergency funds.
  An overdraft account allows you to borrow money from your bank up to a certain limit when your balance is low or negative. This can help you cover unexpected expenses or cash flow gaps without missing payments or incurring fees.
• – Pay for what you use.
  Unlike a personal loan or a credit card, an overdraft account does not charge you interest on the entire limit, but only on the amount you use. You also do not have to pay any monthly fees or charges as long as you stay within your limit and make regular deposits into your account.
• – Flexible repayments.
  An overdraft account does not have a fixed repayment schedule, so you can pay off the amount you owe whenever you can, as long as you keep your account in good standing. You can also redraw funds from your overdraft account as many times as you need, as long as you do not exceed your limit. But, you will pay interest on the amount you’ve overdrawn
• – Convenient spending and withdrawals.
  Most debit cards come with an overdraft that allows you to make purchases online or in-store, or withdraw cash from ATMs. You can also access your overdraft account through online banking or mobile apps, and transfer funds to other accounts or pay bills.

Having an overdraft account can be a useful way to manage your finances, especially if you have a high turnover and need fast access to funds on an irregular basis. However, an overdraft account is not suitable for everyone, and you should consider your personal circumstances and compare different options before applying for one.

Risks of overdraft accounts

Overdrafts can be a particular problem for debit card users as it can sometimes be hard for a debit card user to know whether they are getting into debt.  This means that they can sometimes be hit with overdraft interest and there are also penalties which together can be more expensive than a credit card.  However there is no reason for this if a credit card is managed well.

Here are some of the disadvantages of having an overdraft account:

• – Higher fees. Overdrafts tend to carry higher interest rates and fees than many other loans. For example, some banks charge a monthly fee for having an overdraft facility, plus interest on the amount you overdraw. You may also have to pay a fee every time you use your overdraft account or exceed your limit.
• – It’s still debt. Even though an overdraft account is linked to your bank account, at the end of the day, it’s not your money. It is a loan that you have to repay eventually. If you use your overdraft account too often or for too long, you may end up in a cycle of debt that is hard to break out of.
• – It’s easy to ignore. Because an overdraft account is not as formal as a loan with regular repayments, you may not notice how much you’ve spent. This adds up in interest and might become a problem making repayments.
• – It may require security. If you’re getting an overdraft for a business, the provider may request that a physical asset is used as security. This can pose additional risk to your business or personal finances, because if you are unable to make repayments on the overdraft account, the lender could repossess the secured asset.

Authorised overdraft interest is usually charged at a similar rate to that of a low interest credit card, but at a considerably lower rate than most other credit cards.  This is because a borrower who has a transaction account with a bank is usually a far better credit risk than a borrower who has no other link to a bank.  However there are also issues if the overdraft is unauthorised, at these points the overdraft interest rate can be very high.

Overdraft penalties can add significantly to the cost for a debit card user.  Many debit cards are not refused when they are presented and there is no money in the account (unlike cheques) and they can easily add on to the overdraft without the card user being aware of this. If the overdraft goes over the agreed overdraft limit then the card user may find that they are in financial trouble as the fees are quite high.  If the card user is in the habit of constantly going over the overdraft limit then this will add a considerable amount to their bank costs over the long term.

It is important for a debit card user to read their bank statements to know where their financial situation rests.  It is also a good idea to negotiate a higher overdraft limit if there is a chance of going over this limit.  The increased fee will pay for itself in missed penalties

Use an overdraft responsibly

Overdraft accounts and debit cards can be useful tools for managing your finances and avoiding fees when you need some extra cash. However, they do come with risks and costs that you should be aware of before you apply for one.

You should also make sure you can repay your overdraft balance as soon as possible to avoid interest charges and other fees. Overdraft accounts and debit cards can help you manage your cash flow and cover unexpected expenses, but they aren’t a substitute for saving and budgeting.