Everything you need to know about overdrafts
What Is an Overdraft?
An overdraft is, effectively, an agreement with your bank that you can spend more money than you have available in your current account, up to an agreed limit. This debt is known as an overdraft facility. You pay interest on the amount of money you borrow, along with other interest and fees which vary from bank to bank.
To minimise how much an overdraft costs you, you need to repay what you’ve borrowed, just as you would with a loan or credit card.
How can I avoid overdraft charges?
The best way to steer clear of charges is not to use an overdraft facility. Knowing how much money is in your account and keeping a close eye on what you spend is the best way to stay in the black or start to pay back an overdraft.
If are already using an overdraft facility, you could look to save money by switching to a bank that charges a lower interest rate for overdraft debt. Some banks offer an interest-free overdraft facility (for example, First Direct currently offers £250 interest free), so this could be a good option to reduce the interest you are paying. Use comparison sites to scout out the bank accounts offering the cheapest overdrafts and look to switch your current account and overdraft facility.
Know What You’re Paying
Many people use an overdraft facility without really knowing what it costs them. Knowing how much you are paying out for an overdraft can be a good incentive to try and get it paid back as quickly as possible. Look through bank statements and add up the costs for your overdraft over the last six months; it is likely to be much more than you think.
The rules on charging for overdrafts has changed, and by April 2020 all banks must have stopped charging customers one-off fees for unarranged overdrafts and instead charge a flat interest rate on overdrawn balances. The scrapping of these fees is good news if you are someone that dips into an unarranged overdraft frequently, but you will probably find that the overall interest rate you pay is set to increase. A typical APR for an overdraft facility is now around 39.9%, so it is an expensive way to borrow.
Look at Alternatives
If you have a large overdraft debt that you are unlikely to be able to pay back quickly, it could be worth considering moving the debt to a credit card with a 0% offer. Use comparison sites to find out which credit cards have 0% deals running and which ones will let you transfer cash to a bank account.
If you can then clear the credit-card balance by the end of the promotional period, you will avoid paying any further interest on that debt. Make sure you factor in the fee for transferring the balance though, which is usually between 1% and 3% of the total borrowing.
Remove the Facility
Once you get your bank account back in credit, it can be a good idea to remove the overdraft facility entirely, or at least to reduce it to a nominal amount to act as a small buffer. Removing the facility removes the temptation to use it. If you need to borrow money for an unexpected expense, an overdraft is unlikely to be the cheapest option anyway.