More than 2 million people in the UK are in permanent overdraft. So, this type of borrowing has very much become a part of daily life. Overdrafts can have many uses, from providing a safety net when your payments come out at the end of the month, to resources to make a one off payment. They are a short-term borrowing option (a form of high cost short term credit like payday loans) and if you’re applying for an overdraft you should aim to use it temporarily. Like any type of credit, the more you know about overdrafts, the easier it will be to make sure that you get the best deal.
What is an overdraft?
It’s a type of credit facility that allows you to borrow via your current account. You can borrow and repay the money as you choose, as long as you don’t go over the overdraft limit. An overdraft needs to be agreed with the bank in advance and there will usually be charges to pay.
Authorised overdraft. This is where there is an agreement in place that you can go “into overdraft” on your account i.e. beyond the point where there is £0 available. The bank will authorise an overdraft up to a certain figure (e.g. £500) and you’ll be told in advance what you’ll pay for the overdraft in terms of fees and interest.
Unauthorised overdraft. This is essentially where you keep spending even when you have £0 in your account but the bank has not agreed to it. An unauthorised overdraft may also arise if you go over the overdraft limit the bank has set. If you find yourself in unauthorised overdraft then try to get out of it as soon as possible. This type of overdraft attracts the most significant fees and costs and they can accumulate, fast. Many lenders charge a fee per day so the longer you are in the unauthorised overdraft, the higher the cost climbs. If you go into unauthorised overdraft you may have to pay:
A monthly fee (£5 -£35+)
A daily fee (£1 – £6 per day up to a max monthly limit)
Transaction fees (up to £25 per transaction if the bank allows a payment to go through)
How to keep your bank overdraft costs down
Don’t go over the limit – as soon as you do, the costs begin to mount
Make sure your limit is high enough – if it’s too low you may end up going over it
Opt for an interest free overdraft – these are always provided to students and it’s also possible to find one if you’re not at university. 0% overdrafts are usually offered for a limited period and may require a certain level of monthly payments into the connected account.
Make sure you know what the fees and charges are for both authorised and unauthorised overdrafts in advance. The only way to ensure you’re getting the best deal on your overdraft is to have a clear idea of what those costs are and how they compare to other options.
Shop around to find the best deal. Like any other type of credit today lenders are competing for customers and you could get a better deal by banking elsewhere.
Try to stay in credit. If you don’t use your overdraft then there’s nothing to pay for. This may mean reviewing how you manage your money, for example looking at ways to cut back, budgeting and avoiding cheque payments, which can come out at unexpected times.
Paying back an overdraft
If your overdraft costs have escalated, or you just want to reduce your level of debt, then you may want to pay back your overdraft. You’ll need cash in the bank to repay whatever you borrowed. If you don’t have it then you could:
Use a personal loan. Borrow what you need to pay off the overdraft and then repay the loan on a monthly basis. This is a good option if the interest rate on the loan is lower than the overdraft costs and/or you know you’d never get around to paying the overdraft off any other way.
Transfer the balance to a credit card. There are some specialist money-transfer cards that allow you pay cash in to your bank to pay off your overdraft. Look for a 0% card with a low transfer balance fee. This is especially useful if you have a large overdraft to pay off.
Spend less. Sometimes there’s just no other option than to reduce your outgoings if you want to get debt free.
An overdraft can be a useful credit facility to have. It’s important to be aware of the potential fees and to be confident that you won’t fail to stay within the limit and end up in a costly unauthorised overdraft as a result.
Alex Hartley is a keen advocate of improving personal finance skills. She's worked at Solution Loans since 2014 and written hundreds of articles about how people can manage their money better. Her interest in personal finance goes way back to...Read more about Alex Hartley