What is an overdraft?
An overdraft facility is a small loan that is automatically linked to your checking account – the account you use day to day for shopping, bills, and your salary. You do not need to apply for it separately or sign a contract to use it. Once your bank has set it up, you can spend more money than you actually have in your account. Your balance then goes negative, into what is usually called 'the red'.
That negative balance is really a loan. The bank is lending you the money that is missing. In return, it charges interest – a fee for using the bank's money.
How does overdraft interest actually work?
With an overdraft, you only pay interest for the days your account is actually negative, and only on the amount it is negative by. If your balance is minus 200 euros today and back to zero tomorrow, you only pay interest for that one day and for that 200 euros.
That sounds fair enough at first. The real issue is the interest rate – the percentage charged per year on the negative amount. For an overdraft, this rate is almost always much higher than for other types of loans. The exact rate is set by each bank and can change over time. The important thing to understand: the basic pattern – overdrafts are expensive – holds true no matter which bank you use.
Why is an overdraft more expensive than a regular installment loan?
A regular installment loan – a loan with fixed monthly payments – is carefully planned out. You receive a fixed amount, say for a larger purchase, and pay it back in fixed, known-in-advance installments over several months or years. The bank knows the exact amount and the exact term, so it can assess the risk well. That is usually reflected in a lower interest rate.
An overdraft works differently. The bank does not know how long you will use it, how large the balance will eventually grow, or how certain repayment is. The bank charges a much higher interest rate to compensate for that risk and uncertainty. On top of that, an overdraft is extremely convenient – there is nothing to apply for, nothing to sign, no paperwork to submit. That convenience comes at a price.
A simple worked example
Here is a strongly simplified example with round numbers. This is not a real offer from any bank – it is only meant to illustrate the idea.
Suppose you overdraw your account by 1,000 euros for an entire month. In this example, the overdraft interest rate is 15 percent per year. For one month, that works out to roughly 15 percent divided by 12, or about 1.25 percent. That comes to around 12.50 euros in interest for that single month.
A regular installment loan for the same amount might, in this example, carry an interest rate of 6 percent per year. For one month, that would be only about 5 euros. The difference – more than double in this simplified example – shows why relying on an overdraft for a long time can really add up. The longer the account stays negative, the more the interest accumulates.
These numbers are chosen freely just to show the principle. Actual interest rates at real banks and on real loans may be higher, lower, or structured differently.
When does an overdraft turn into a long-term habit?
An overdraft is really meant for short gaps – for example, when your salary arrives in three days but a bill is due today. Being negative for a few days usually does not cost much.
It becomes a problem when the account is negative all the time, or keeps dipping back into the negative. This often happens gradually: a small negative balance is left over each month and never fully cleared. Because using an overdraft is so effortless – there is nothing you actively have to 'do' – many people do not notice how much interest adds up over months or years.
One sign that an overdraft has become a long-term habit: the account almost never reaches zero or a positive balance, even right after your salary arrives. If that sounds familiar, it is worth considering another option – for example, a regular installment loan with a fixed amount and fixed, lower payments, to pay down existing debt in an orderly and cheaper way. You can see an overview of how such installment loans are generally structured at /en/loans.