An overdraft is a form of borrowing on a current account that lets the balance fall below zero up to an agreed limit. Interest is charged on the amount used, and going beyond the limit can trigger further refusals or charges.
In one line: An overdraft lets a current account go into the red up to a set limit, with interest charged on what is used.
How an overdraft works
An arranged overdraft is agreed in advance with the bank up to a stated limit. An unarranged overdraft happens when spending pushes the balance past that limit or into the red with no facility in place.
Since April 2020 the FCA has required a single interest rate rather than daily or unpaid-item fees, and rates are often near 39.9% EAR. Borrowing 400 GBP for ten days at that rate costs roughly 4 GBP in interest.
Interest usually accrues daily and is charged monthly, so a balance that returns to credit quickly costs far less than one held overdrawn for the whole month.
Arranged vs unarranged
An arranged overdraft is pre-agreed and predictable. An unarranged overdraft is not, and although the old high penalty fees are gone, the single interest rate still applies and payments can be declined.
An overdraft is repayable on demand, unlike a fixed-term loan, so the bank can reduce or withdraw the limit, which makes it short-term rather than long-term borrowing.
Primary source: FCA overdraft rules (PS19/16)