The Double-Edged Sword of Overdraft

The Double-Edged Sword of Overdraft

The Double-Edged Sword of Overdraft

Overdraft can be extremely helpful when you suddenly realize that there isn’t enough money in your account to cover tonight’s loan payment. Overdraft can save you from quite a bit of stress, but unfortunately there is a darker side. Overdraft can quickly become expensive and tragically, people can become “trapped” in perpetual overdraft.

For those that don’t know, overdraft allows individuals to borrow money from the bank when they use more money than they have. It’s meant to offer short-term protection from spending fluctuations and the stress that comes along with it.

While I was a Financial Advisor for a large commercial bank, I met too many people that had become stuck in overdraft. Usually, it was the same repeated cycle of having a negative balance, going further into the negatives by paying expenses, a deposit occurs that brings them close to zero and the process would start again. Ultimately, it was a never-ending cycle that kept individuals in overdraft until further action was taken.

The bank fees for overdraft are quite expense and further, it looks unfavourable on a credit bureau. The major Canadian banks have a monthly or per usage overdraft fee, plus a compounding interest rate. Currently, the monthly fee is either $4 a month for unlimited overdraft usage or $5 per overdraft use. Per usage fees can be dangerous because they charge the fee for everyday that your negative balance increases (which can quickly add up). The stated annual interest rate is approximately 21% (varies insignificantly between banks) or the equivalent of an annual effective rate of 35.30% (due to compounding interest). As you can see the banks like it when you use your overdraft. Further, they are able to change their fees whenever they choose with notice.

Now what can you do if your living in overdraft? The simplest thing to do is consolidate your overdraft debt in a lower interest debt facility. This could be a line of credit, a loan or even a low-interest credit card. You should then create a plan to pay off this debt by looking at the differences between your income and expenses. Analyzing your cash flow will also allow you to see if you have any shortages that are pushing you towards overdraft. As I always preach, it’s recommend that you speak with a trusted advisor if you don’t have a low-interest debt product or need further assistance.

As always, if you have any further questions or comments please contact the Friendly Financial Coach at info@ffcoach.ca or 416-231-6718. Also, please sign-up for our unique newsletter below.

One thought on “The Double-Edged Sword of Overdraft

  1. Seng

    I never knew this. It must be the reason why paymnet verification takes so long, and why there are so many impediments to setting it up. I wanted Google to pay me via electronic, but they said it would take a month even though the medium itself takes mere seconds.

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