An overdraft gives a customer access to more money than is actually in his or her account. An overdraft facility can be arranged or unarranged.
This is an amount a bank agrees to advance after the customer has used up his or her funds in a particular account. A bank may, for example, advance $500 after a customer’s balance has reached zero.
Here, a customer withdraws money either beyond the available balance or beyond an agreed limit without the agreement of the bank. In the first situation, the customer simply spends money that is not there; in the second, he or she has an arranged overdraft and then spends beyond that limit – and hence goes into an unarranged overdraft. In either case, it is at the bank’s discretion whether to accept the overspending. The main consideration is the customer’s credit history. Customers with a good credit history are more likely to be permitted to exceed the limit on their account than those with a poor credit history.
Banks may allow customers to go into unarranged overdraft. This is usually set out in the terms and conditions of the account. Again, it will be at a bank’s discretion whether to allow the overspending. The terms and conditions will say something along the following lines: “If you try to make a payment out of your account for which you do not have available funds, we will treat this as a request for an unarranged overdraft. We will consider whether we agree to your request, taking into account your personal circumstances. We will not be liable to you if we do not agree to give you an unarranged overdraft.”
Charges for unarranged overdrafts
Banks can charge a fee and interest on overdrawn amounts, but this must be specified in the account’s terms and conditions. An example is the following: “When your account goes into unarranged overdraft or you exceed your arranged overdraft limit, you will be charged interest at our unarranged overdraft interest rate and an unarranged overdraft fee.”
How to avoid going into overdraft
Keep a close eye on your account so you know what your balance is before you spend money. Customers are responsible for ensuring they have enough money in relevant accounts to cover payments. Mobile banking allows you to check your available funds wherever you are, including, for example, in a shop before making a purchase.
Ask your bank whether it can load a “no overdraft” alert on your account. Make sure you understand how such alerts work. Some alerts prevent transactions altogether if an account has insufficient funds. Other alerts may not stop some electronic transactions (such as automatic payments), which can result in fees.
Alternatively, ask your bank if it can send a text warning when your account balance is low. But remember, even with these precautions in place, it remains your responsibility to be aware of your account balance.
Ensure you have enough money in relevant accounts to cover payments to avoid overdraft fees.
Bank had no responsibility for overspending
Ravi withdrew funds from his savings account while travelling overseas for several months. On his return, he discovered the account was $1,000 overdrawn because his bank had honoured withdrawals even though there wasn't enough money in the account.CASE 2
Abuse towards staff justified closing account
David's bank wrote to advise him that it would close his accounts because of his history of abusive behaviour towards bank staff. It said he had 14 days to make other banking arrangements. The bank said he was often moody and angry and used derogatory language. He also made a staff member uncomfortable with inappropriate questions about her life and income.CASE 3
Former student not entitled to special interest rate
Ali took out a student package with his bank when he went to university. It gave him an interest-free overdraft while studying and for two years afterwards. At that point, his student account became a standard account with standard fees, including standard interest rates on his overdraft.
Concerns about lending decisions
We receive complaints about banks both refusing to lend and allowing customers to borrow when the customers say they could never have afforded the repayments.
Lending decisions are usually a matter of commercial judgement for banks, something beyond our powers to investigate. We can, however, investigate administrative errors in the lending application process. This includes complaints about a refusal to lend and also what is sometimes termed "irresponsible lending".
How banks evaluate applications
In considering a lending application, a bank should take into account, among other things, the customer’s income and whether it is secure, what other debt the customer has, and the customer’s credit rating.
Banks rely on getting honest, accurate information. Usually, a customer is required to sign a declaration confirming the information he or she has given in support of an application is accurate. Banks should make further enquiries if the application is incomplete or something in it suggests the information is incorrect.
Banks must provide credit or increase a customer’s credit limit only when the information they have available leads them to believe the customer will be able to meet the terms of the lending.
Banks must consider all relevant information available to them from throughout their various departments when making a lending decision. For example:
- it may not be enough for a bank to consider only credit card department information when other departments also hold information relevant to a loan application
- the fact a customer has previously met payments on a current credit facility may not in itself establish that the customer can repay a higher level of debt; a bank should check other information it holds on the customer.
Our approach to lending complaints
In order to conclude that a bank lent to a customer who lacked the means to meet loan repayments, we must be satisfied the bank knew, or should have known, the customer could not afford the loan repayments when he or she requested or drew down the loan. This applies to any type of lending, whether secured or unsecured, including mortgages, personal loans, business lending, credit cards and overdrafts.
In order to conclude that a bank acted incorrectly in refusing lending, we must be satisfied an administrative failure occurred in the bank’s assessment of the application.
Factors we weigh up
When considering complaints about lending, we look at:
- what information the bank asked for and what information it received about the customer’s ability to repay the loan
whether the bank considered all information available to it
whether the bank complied with its own policies and procedures on credit assessment
- whether anything should have prompted the bank to seek more information
- whether the bank waived a particular policy requirement, and if so, why.
Generally we are unlikely to find in favour of a customer who was subsequently unable to service a loan if the customer:
- actively sought the loan
- was not affected by any disability at the time
- met, or almost met, the bank’s usual lending criteria, and the bank made appropriate enquiries.
We are also unlikely to find in favour of the customer if:
- the bank asked all the right questions, and they were appropriately worded
- the customer gave incomplete information about his or her financial position or gave inaccurate responses.
When we uphold lending complaints
Generally, we recommend a bank writes off some or all of the interest and charges associated with a loan if we find it has lent to someone who was unable to meet loan repayments and who benefitted from the loan (for example, by buying a property he or she wants to keep). This is because the customer should not have to bear the total cost of the borrowing.
In most cases, the customer will still be responsible for repaying the borrowed amount, and we will generally encourage the bank and customer to come to a repayment arrangement the customer can afford.
We may suggest a bank writes off a debt if there is no possibility of the customer making any repayments. In such cases, the bank may make an adverse credit listing against the customer to ensure all potential future lenders are aware the customer has previously defaulted on lending.
When we uphold refusal-to-lend complaints
We will ask a bank to reassess an application if we find that it made an administrative mistake in assessing a lending application (for example, by wrongly calculating an applicant’s income). We cannot make a bank approve a lending application because that is a matter of commercial judgement for the bank, but we do expect banks to follow an appropriate administrative process in assessing applications.
Loan-to-value ratio restrictions
Banks may decline more low-deposit home loan applications as a result of the Reserve Bank’s loan-to-value ratio restrictions. These require banks to restrict residential mortgage lending exceeding 80 per cent of a property’s value to a maximum of 10 per cent of all new mortgage lending.
For more information, see the Quick Guide on Loan-to-value restrictions. See also the Quick Guide on Guarantees. This has information for those considering guaranteeing someone else’s borrowing. The Reserve Bank website also has information about loan-to-value lending restrictions.
Transferring credit card debts
You must apply for a credit card account at the new bank if you don't have one there already. You will be assessed against the bank’s credit criteria. Check your debt before you apply to ensure it includes purchases or payments since your last statement. Note that interest accrued during the current month may not show up.
If the bank approves your application, it will pay off your card debt debit at your other bank and create a new debt. It will tell you the credit limit it is prepared to give you. The total of all transferred balances must not exceed that limit. You may be able to transfer store card or personal loan balances, but check first with the new bank about any exclusions.
You may have to close your existing credit card account if having two credit cards will exceed your debt servicing ability. Talk to your card provider. It's your responsibility as the customer to close accounts.
Interest rates on transferred balances
Transferred balances may have special low interest rates, but new purchases and cash advances are usually subject to the bank’s normal rates. Check the card’s terms and conditions to see how interest rates apply. Interest rate deals may be for a set time only. Make sure you know when that period ends and what the subsequent interest rate will be.
Allocation of repayments
Generally, your credit card repayments will be allocated to the balance with the lowest interest rate. If you have a transferred balance at a special low interest rate and you put purchases on that card, your repayments will probably be allocated to the transferred balance rather than to the recent purchases. This means any purchases or cash advances you make after the transfer won't be paid off until you have repaid the transferred balance.
Payment allocations are described in the credit card terms and conditions. Talk to your bank if you are unclear how payments will be applied. You need to continue making minimum monthly repayments and should check out potential penalty fees if you fail to make them.
Early repayment charges
Customers who borrow money at a fixed interest rate for a fixed term enjoy the benefit of knowing exactly what their repayments will be over the period of the loan. They are not affected by any rise or fall in interest rates during that time. In return, banks get a pre-determined return on their money.
But if customers repay their loan early (or make a significant lump sum payment before the end of the term), banks may not be able to lend that money to someone else at the same rate. That’s because interest rates may now be lower than when the loan was taken out.
To recoup lost earnings, banks apply an early repayment charge (also known as a break fee). In order to apply an early repayment charge, it must be stated in the terms and conditions of the loan contract – hence the importance of reading a loan contract carefully. The terms and conditions may also allow for an administration fee when a loan is repaid early. This is a flat fee and quite separate from an early repayment charge.
Calculating the charge
The Credit Contracts and Consumer Finance Act 2003 regulates early repayment charges on consumer loans. Consumer loans are loans that have been advanced for personal, domestic or household purposes.
The Act allows lenders to recover their costs when a borrower repays a loan early. The Act contains a formula for lenders to use when calculating how much they lost, but it is not compulsory to use this formula (known as a “safe harbour” formula). They can use their own, but their formula must result in a reasonable estimate of how much they lost as a result of early repayment. Lenders must tell borrowers whether they are using the safe harbour formula or their own formula, and they must also explain how they will calculate the charge.
Calculating early repayment charges involves a complex formula. Many – but not all – banks base the charge on the difference between the wholesale interest rate on the loan and the wholesale rate applicable when the loan is repaid early (other factors are also included in the calculation). If rates have risen since the loan was taken out, a charge won’t be applied because the bank can lend the money again at a higher rate.
Banks can’t give prospective borrowers an indication of how much it might cost to break a loan early because the calculation requires two inputs that cannot be known in advance: the point at which the borrower will decide to repay the loan early, and the interest rate applicable at that future point in time. Only with that information can banks calculate any loss and any corresponding charge.
There is nothing preventing borrowers from trying to negotiate a lower charge, but banks are under no obligation to agree. Any reduction is entirely at banks’ discretion. Borrowers should assume banks will apply the charge in full.
Customers are frequently surprised at the size of the charge they face during times of falling interest rates. That surprise often leads them to complain to us. But it is important to remember that an early repayment charge is not a problem in itself – provided the loan contract stipulates that the bank can take such a step if the loan is repaid early.
Complaints we receive include:
- A bank failed to tell a customer about the charge, either when the customer took out the loan or repaid it early. For example, a bank might have told a customer about an administration fee, but not about the early repayment charge. Or a bank might have failed to tell a customer about the charge when the customer said he or she might repay the loan early.
- A bank failed to tell a customer about how it would calculate the charge, or didn’t explain the calculation properly. Bank staff might not, for example, have been able to explain how the charge was calculated, and did not refer the query to someone who could.
- A bank made a mistake in the way it calculated the charge. We will check whether the bank calculated the charge according to the contract. We may also refer complaints about methodology to the Commerce Commission, which enforces the Credit Contracts and Consumer Finance Act 2003 and has greater powers to take action against lenders that have breached it.
- A bank gave incorrect advice about the type of loan most appropriate to a customer’s circumstances. A customer might, for example, have told a bank of his or her intention to sell a property within a specific time, and the bank recommended a fixed-rate loan whose term extended beyond the point when the customer was intending to sell.
Cash incentives and claw-backs
Banks will sometimes offer a cash incentive to encourage people to take out a home loan with them rather than with a competitor. If you accept such an incentive but switch to another bank before repaying the loan (or you break the terms of the loan in some way), the bank will often ask you to repay the cash incentive. This is called a claw-back. The bank’s right to seek the return of a cash incentive must be set out in the terms and conditions of your loan agreement (or in a separate contract). Check whether this will be the case before accepting a cash incentive.