An overdraft limit is the highest amount of credit or money a person has available for overdrafts on a particular account. For example, a person can usually withdraw or make payments up to the amount of money he has available in his account. If a withdrawal or payment causes him to exceed this amount, this is referred to as an overdraft. When a bank allows a withdrawal or completes a payment for which the person does not have money available, it is extending credit to the account holder and usually places limits on the amount of credit it will extend. An individual may also have a separate account or a credit card to use for overdrafts, in which case he could designate his own overdraft limit.
An overdraft limit may be placed on an account by a financial institution or it may be self-imposed. For example, some banks automatically pay overdrafts for account holders in good standing and place limits on how much, and when, they will pay them. In other cases, however, a person may open an overdraft account with a bank for this purpose. Overdrafts are then taken from this account up to the limit on the account.
Sometimes a person may use one of his other accounts to provide his own overdraft protection. For example, if a person has a checking account, he may use his savings account to provide overdraft protection. In some cases, a person may also use one of his credit cards as overdraft protection on his checking account. In such a case, he may decide the amount of overdraft protection he wants for his account instead of having the financial institution set the limit for him.
When a bank or other financial institution sets an overdraft limit, it may consider some of the same factors it might evaluate when deciding whether or not to extend credit or offer a loan. For example, a financial institution may check an account holder's credit history before extending overdraft credit. If a person has a low credit score, the bank may deny his request for overdraft credit, or it may offer the account holder a low overdraft limit.
Having an overdraft account, credit line, or other protection doesn't always help a person avoid all overdraft fees. If a person exceeds his limit, he may face fees despite the creation of an overdraft account or the granting of overdraft credit. As such, a person with overdraft protection may do well to continue to carefully monitor his account. This way, he can avoid accumulating so many overdrafts that he exceeds the limit.