phreaks wrote:Think about it, what is an overdraft?
An overdraft is simply a short-term loan, there really is no other way to define it.
No, it's not. And I already explained why. But let me elaborate for the slow.
A loan is a transaction entered upon by two parties, where one party agrees to provide money to the other for a given interest rate. If the loaner is tight on funds, he can simply choose not to make the loan.
An overdraft is not a loan. It's not agreed upon by the bank up front. There's a middle man involved, to whom the bank has some responsibility to ensure he receives his money under reasonable circumstances, and so they pay him even though you don't have the funds to do so. This is not a loan to you, this is a necessary (from the banks point of view) debt the bank undergoes to ensure it's reputation. After this, the bank must extract compensation from you. Again, this isn't a loan. The compensation extracted must do three things. First, it must cover the amount of the original transaction. Two, it must cover the amount of money required to handle this transaction, which is larger than the normal amount because of the added burden of dealing with retrieval of money from you. Third, they must provide a penalty large enough to disuade people from treating this process like a LOAN! Oh boy, did I just make a point there or what! Overdrafts put a bank in the position of not being in control of their own assets. Loans do not. Therefore banks are happy to make loans (for profit, of course), but are not so happy to have to cover overdrafts.
Turn this around and pretend to be the bank. Let's say you have a roomate. He asks if he can borrow $10 to pay for a pizza delivery, that he'll pay you back for tomorrow. This doesn't bother you, and you either lend it to him or not. Now, let's imagine the next night he orders pizza again, but you aren't there, so he takes $10 out of your desk drawer or some other place you left money laying around. You're likely to not be so happy go lucky about this, even if he pays you back the next day, now are you? Why should a bank be different?
The bank loans you the money and automatically pays it to the debtor. The bank doesn't have to pay them, they could simply refuse the charge, at which point the debtor that originated the charge is responsible for collecting the cash value from you.
And the debtor then decides to no longer accept checks from the bank, because of the hassle involved here. Not good for the bank. So you've placed the bank in a bad situation. They either pay the debtor and take on the responibility of collecting from you, or they don't and have the potential of ruining their reputation and losing business. So, they choose to pay, but charge you a fee to deter you from putting them in this same situation again.
I hate overdraft fees as well. Especially large ones, when the overdraft is small. And banks do play tricks to catch you in an overdraft (such as applying debits before credits), which is wrong, IMHO. But you simply can't compare an overdraft to a loan. They are not the same thing.
The fee is the interest rate of the loan. That's pretty much how it works.
Nope, the fee is not the interest rate. Look above.
In fact here is the definition from investopedia.
An instant extension of credit from a lending institution.
If you have an overdraft account, your bank will cover checks which would otherwise bounce. As with any loan, you pay interest on the outstanding balance of an overdraft loan.
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No clue what Investopedia is, or if this is just something taken out of context. But this in this context, this quote is simply wrong. An overdraft charge is not interest. It's a flat fee, it's charged once and not as an ongoing monthly charge.
That said, many banks do have some form of "overdraft protection" which function more like a loan (no overdraft charge, but interest is accrued on unpaid overdrafts). That might be what Investopedia is referring to.