An overdraft is when you enter 'negative territory', of your bank account. It is simply taking more money out of the account, than there is available within.
It tends to be used in emergency cash requirement situations, for example, due rents and tax payments.
There are two types of overdraft...
- Authorised Overdraft : these are arranged in advance with banks or lenders. The cost is agreed.
- Unauthorised Overdraft : when no agreed value has been made, when you draw out more money than what is available. When you then go to use this, hefty fees and charges are implements, for exceeding the autorised level.
Generally, banks are reluctant to give overdrafts - ultimately because there is high uncertainty; the capital provided may or may not be used. Due to this, they charge more for these facilities than they would for fixed lending or term loans.
Think of it like this ... it is a debt - so an overdraft is a loan from the bank, being borrowed and needing repaying.