Overdrawn again? Here's the lowdown on overdrafts and how to keep on the right side of your bank.
The basics on being overdrawn
Overdrafts are an agreed cash-borrowing limit arranged with your bank. It gives you a flexible way to manage your money and can provide you with short-term funds if you don’t have enough money, but it’s not a loan.
Overdrafts can help you if, for example, you have an urgent phone bill to pay today, but the funds won’t go into your account until next week. The overdraft enables you to pay off the bill, without having the actual money in your account.
How to arrange an overdraft
As with all forms of credit, you must be over 18 years of age before you can apply for an arranged overdraft. If you’d like to set one up you should talk to someone at your local bank branch. Some banks or building societies can arrange an overdraft through their telephone or internet banking service. However, not all bank accounts offer overdraft facilities.
It is best to avoid going overdrawn if you haven’t arranged it with your bank, or if you are about to go over your overdraft limit. If you do not arrange to have an overdraft or an extension before the money leaves your account, you’ll face overdraft charges in the form of interest. The bank could also continue to charge you extra fees every time it sends you a letter telling you you are overdrawn.
Changes to overdraft charges
The Financial Conduct Authority changed overdraft rules in April 2020. Where astronomical overdraft charges used to be commonplace, banks can now only charge users a simple annual interest rate for using an unauthorised overdraft or going overdrawn – putting an end to additional fees and charges. The interest will still add up, we would always recommend trying to clear your overdraft where possible.
What are the benefits of an overdraft?
Overdrafts are ideal for borrowing money you know will be replaced quickly when your salary or regular funds are paid into your account.
However, it doesn’t work out as good value if you are borrowing thousands of pounds in this way and never clearing your debts.
If you’re looking for other borrowing options, credit cards (as long as you keep up with your payments) are a good way to borrow money while building up your credit score. Check out our article on types of credit here.
What are the disadvantages of overdrafts?
- Some banks charge a fee for setting up an overdraft
- Overdraft facilities can be withdrawn or reduced by banks or building societies at any time
- When you go overdrawn before agreeing a limit with your bank you will have to pay additional interest
- If you go overdrawn above the limit agreed with your bank you will also face higher interest
- In the event that you are overdrawn and decide to transfer your bank account you must pay off your overdraft first because you are, in effect, in debt to the bank
Free or cheap overdrafts
It’s worth checking if your bank has a buffer zone that allows you to go slightly overdrawn each month without incurring the interest usually associated with unauthorised overdrafts. There may be a small annual charge for this facility. Some banks and building societies also offer preferential terms to students, which could mean that overdrafts attract reduced interest rates or there’s a certain interest free amount that you can dip into.
Paying off your overdraft
Ideally, you shouldn’t live constantly in your overdraft – though it is very common. Try and reduce how much you’re overdrawn by each month, so eventually you’re back in the black.
Graduates! One thing to watch out for is your interest-free overdraft being reduced once you leave university. Most students enjoy a large interest-free overdraft, but the minute you graduate it can be reduced aggressively and methodically, usually by about £500 each time.
Thanks to the Citizens Advice Bureau for help with this article. For more advice on all things money:
By Holly Turner
Updated on 28-Jul-2021
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