Overdrafts Explained

 

When you go into your overdraft, you’re getting into debt. An overdraft should be for short-term borrowing or emergencies only. It’s important you manage an overdraft like any other debt to make sure the costs don’t get out of hand. This guide looks at how overdrafts work, how to stop going over your limit and how to avoid bank charges.

 

How Does an Overdraft Work?

 

An overdraft lets you borrow money through your current account by taking out more money than you have in the account. There’s usually a charge for this.

 

You can ask your bank for an overdraft – or they might just give you one – but don’t forget that an overdraft is a type of loan. If you need to borrow money, there might be cheaper ways to do it. It’s important to always find the cheapest way to borrow.

 

Types of Overdraft

 

Authorised overdrafts: are arranged in advance, so they’re also known as ‘arranged’ overdrafts. You agree a limit with your bank, and can spend money up to that limit. Your bank will charge you interest, and sometimes other fees on top.

 

Unauthorised overdrafts: these are also known as ‘unplanned’ or ‘unarranged’ overdrafts and happen when you spend more than you have in your bank account without agreeing it in advance. This includes going over the limit of an authorised overdraft.

 

Recent Overdraft Changes

 

Major changes affecting your overdraft were introduced in April 2020. Banks used to charge higher fees for unauthorised overdrafts, but from April 2020 they won’t be able to.

 

Interest on all overdrafts will be charged at a single annual interest rate (APR), making it easier to compare charges between accounts.

 

Interest rates from banks and building societies on their overdrafts range from 19% to 40%.

 

If you’re worried, unsure or think you’ll be worse off because of these changes, then:

 

1. Speak to your bank or building society as soon as possible. They can help explain your overdraft and, if you’ll be worse off, consider how it can help you during this change.

 

2. If you feel vulnerable for any reason, explain your circumstances and your provider is obliged to take this into consideration.

 

3. If these changes mean you’ll struggle to pay bills or fall into debt, or you are already in debt, you should find help as soon as possible.

 

Do You Need an Overdraft?

 

Overdrafts can be useful for some people. They can help you avoid fees for bounced or returned payments. These happen when you try to make a payment but your account doesn’t have enough money in it.

 

But overdrafts should only be used for emergencies or as a short-term option.

 

If you’re using your overdraft a lot, read our tips below on how to avoid doing this. They could help you save money. If you find you’re constantly in your overdraft and don’t have the money to pay it down quickly, it may be cheaper to borrow using a personal loan or 0% credit card.

 

The Financial Conduct Authority (FCA) found that many people underestimate how much they use their overdrafts. If you’re using your overdraft more than you think, it could be costing you more than you realise.

 

Tips for Controlling Your Overdraft

 

Keep an eye on your account balance. It may seem obvious but keeping track of your account balance is one of the best ways to avoid overdraft costs. Make it as easy as possible by: downloading your bank’s app on your phone; setting up text alerts for when your balance is low; using phone banking.

 

Keep reading your bank’s letters. It’s easy to get in the habit of not opening letters from the bank and assuming they’re just routine correspondence. It’s important to check all letters as the bank might be writing to tell you about a change to your overdraft limit or increase to your overdraft interest rate.

 

Use savings if you have some. If you have savings as well as an overdraft, it’ll be cheaper in the long run to use your savings to pay it off. If you then get an unexpected cost, you can still use your overdraft to pay for it. And if you don’t, you can start building up your savings again, so you’re ready for that unexpected expense.

 

Find ways to live on a budget. To lower your overdraft as quickly as possible, cutting back in other places will help you free up money. The money you save can then be used to pay off your overdraft.

 

Switch banks. Switch to a bank account with lower overdraft charges. If you often dip into your overdraft shop around for one with the lowest charges. You may even be able to switch to an account with a switching bonus, which will help you to clear your overdraft.

 

If You Think You’ve Been Charged Unfairly

 

If you’ve been charged fees you think are unfair, or if you’re really struggling to pay, you might be able to get them back.

 

Don’t go to a claims management firm though – it’s easy and just as effective to do it yourself, and you won’t have to pay someone else.

 

Beware – Your Bank Overdraft Could Be Taken Away

 

One reason that an overdraft isn’t safe for long-term borrowing is that it’s not guaranteed.

 

The bank could take it away at any time and leave you without any money.

 

However, if your bank cancels your overdraft with no warning and you are charged as a result, you might have grounds to complain.

 

If you complain to your bank and you aren’t satisfied with the outcome, you can take your complaint to the Financial Ombudsman Service.