Overdrafts explained

When you go into your overdraft, you’re getting into debt. An overdraft should be for short-term borrowing or emergencies only. Unfortunately, it’s all too easy to treat it as your spending limit rather than as a last resort. Use this guide to find out what an overdraft is, how it works and how to make sure you don’t exceed your overdraft limit and end up paying high fees.

How does an overdraft work?

Fee-free basic bank accounts don’t offer overdrafts. They’re designed for people who have a poor credit record or don’t want to spend more than they’ve got. If you want more information we’ve pulled together a collection of guides, tips and handy links.

An overdraft will allow you to borrow money through your current account.

You might request one from your bank or your account might automatically offer you an overdraft (with your agreement).

Types of overdraft

  • Authorised overdrafts: are arranged in advance. You agree a borrowing limit with your bank, and you can spend money up to that limit through all the normal payment methods.
  • Unauthorised overdrafts: also known as unplanned overdrafts, happen when you spend more than you have in your bank account without agreeing it in advance, or if your bank has agreed an overdraft for you but you go over the limit they’ve set. You will pay extra charges and these can mount up very quickly.

Scroll down for more information on each type of overdraft and how to avoid fees.

Do you need an overdraft?

If you find yourself dipping into your overdraft frequently, you might want to use our Budget planner to take control of your money.

It can be easy to think of your overdraft limit as your spending limit.

But an overdraft should really only be an emergency fund or a short-term credit option.

For example, if you have a higher-than-expected bill and need a bit longer to repay it.

If you want to borrow more than your overdraft allows, or over a longer period, then you would be better off with a different kind of credit.

Authorised overdrafts

A daily fee can be expensive, especially if you only go overdrawn by a small amount.

An authorised overdraft is an overdraft that has been agreed with your bank.

You are allowed to borrow up to a pre-set overdraft limit.

You will normally be charged for using the overdraft, though how much you pay and the type of fee might vary from bank to bank and how much you are overdrawn.

Some bank accounts that charge fees might offer you a limited interest-free overdraft as a benefit of having the account.

The overdraft charge might be made up of:

  • Interest, which can be up to 15-20% equivalent annual rate (EAR)
  • A daily (50p-£3 a day), weekly or monthly fee

Check the fees

It is important to ask the bank to explain all the costs of an overdraft and to read your bank’s terms and conditions for overdrafts.

Many have complicated rules about how much they charge, so it’s important to be clear about the costs of going overdrawn.

There are a few banks that advertise ‘interest-free overdrafts’ but these generally only apply to the first £100 to £300 of the overdraft or to overdrafts on student accounts.

Comparison websites are a good starting point for anyone trying to find a current account tailored to their needs.

Find out more in our guide to Current accounts.

Unauthorised overdrafts (unplanned overdrafts)

Exceeding your authorised overdraft limit, or going into the red when the bank has not agreed an overdraft limit, is known as an unauthorised overdraft (or an unplanned overdraft).

This can be very costly and should be avoided at all costs.

Unauthorised overdraft fees

Unauthorised overdrafts come with lots of different fees.

  • Monthly fee: anything from £5 to £35 or more.
  • Daily fee: can be £1 to £6 a day or more (usually up to a set limit per month).
  • Transaction fees: can be £10 to £25 for every cash withdrawal, Direct Debit or standing order, cheque or card payment you make – whether or not your bank allows the payment.

How to avoid overdraft fees

According to the FCA, you are 24% less likely to incur unarranged overdraft charges if you use a mobile banking app and text alert service.

The best thing you can do is stay within your overdraft limit.

If you think you will go over your limit, talk to your bank and ask for a higher limit or an extension.

You might be charged a fee, but you could save a lot more.

Overdraft fees can quickly spiral, leaving you without enough money and forcing you to use your overdraft again.

If you don’t use the right account, they can also be one of the most expensive ways to borrow in the long term.

Read our guide on how to Take action to reduce your debt.

Always seek authorisation

If you need to extend your overdraft and have a good reason and a plan to repay it then your bank is likely to be more sympathetic – as long as you let them know in advance.

Phone your bank first and ask for your limit to be temporarily increased.

Don’t leave it until the last minute – or worse – after you go into the red.

Read your bank’s letters

It’s easy to get in the habit of not opening letters from the bank and assuming they are 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 fees.

Ask your bank to waive the fee

If you slip up and end up with a fee, ask the bank if they’ll waive it.

Switch banks

Switch to an overdraft-friendly bank account. Many banks offer interest-free, fee-free overdrafts from £100 to £300.

More tips on cutting overdraft costs

Visit MoneySavingExpert for more tips and tricks on cutting the cost of overdrafts.

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 reclaim them.

Don’t go to a claims management firm – 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 withdraw it at any time and leave you without the cash you thought you had access to.

However, if your bank cancels your overdraft with no warning and you incur charges 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.

This article is provided by the Money Advice Service.

Money Advice Service

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