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 spiral. This guide looks at how overdrafts work, how to cut costs and stop going over your limit, and how to avoid bank charges.

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. Find out more in our collection of guides, tips and handy links.

An overdraft will allow you to borrow money through your current account. Usually there’s a charge.

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

An overdraft is a debt. You’re using money that’s being loaned to you from your bank. If you need to borrow money, it’s important to find the cheapest way to borrow.

You can find out more on our page Do you need to borrow money?

Types of overdraft

  • Authorised overdrafts: are arranged in advance, so they’re also known as ‘arranged’ overdrafts. You agree a borrowing limit with your bank, and you can spend money up to that limit through all the normal payment methods. There are often fees even with authorised overdrafts. You can find out more below.
  • 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. They can also happen 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.

How overdraft charges are changing

Major changes affecting your overdraft will be introduced in April 2020, but some banks and building societies will introduce these changes earlier.

There are three main changes being introduced which will affect your overdraft:

  1. Interest on all overdrafts will be charged at a single annual interest rate (APR).
  2. No daily or monthly fees for using your overdraft.
  3. The interest rate on unarranged overdrafts will be no higher than for arranged overdrafts.

This means you might lose your interest-free overdraft and overdraft buffer. However, to be sure, you will need to check with your bank.

Not all banks and building societies have announced what their interest rates will be. However, the ones which have already announced the changes, are charging between 19% and 40%.

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.

Overdrafts can be useful for some people. An arranged overdraft can help you avoid fees from bounced payments for bills that happen when your account doesn’t have enough money in it.

But overdrafts should only be an emergency fund or short-term credit option.

If you’re using your overdraft regularly, read our tips on avoiding using your overdraft, below, to help you save money.

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

Arranged or authorised overdrafts explained

An arranged or authorised overdraft is an overdraft that has been agreed with your bank. It allows you to borrow up to a pre-set overdraft limit.

Fees for using authorised overdrafts

You will normally be charged for using the overdraft, though how much you pay and how charges are worked out will vary from bank to bank and how much you are overdrawn.

The overdraft charge might be made up of:

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

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

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

How to check the fees

It’s important you understand the costs of going overdrawn.

Use our Bank account fees and charges comparison tool to see all the fees and charges that apply to bank accounts – it shows everything from overdraft fees to foreign cash withdrawal charges.

You can also:

  • call the bank to explain all the costs of an overdraft
  • look on the bank’s website for fees for your account
  • read your bank’s terms and conditions for overdrafts in their printed guides

Search for a better current account

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.

Find out more in our guide to Current accounts.

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

Comparison websites can help you find a current account tailored to your needs.

If you have paid overdraft fees in the past, look for an account with lower or no fees.

Can I switch banks if I’m overdrawn?

Yes, you can switch using the Current Account Switch Service.

How can I switch my current account if it has an overdraft?

Make sure you’re getting a better deal before switching your account. Shop around using comparison tables to help find accounts with overdrafts and make sure you check and understand the charges and overdraft rules for each account.

Unarranged or unauthorised overdrafts explained

Exceeding your arranged overdraft limit, or going into the red when the bank has not agreed an overdraft, is known as an unarranged or unauthorised overdraft.

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

Unarranged 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 (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.

Current accounts now have a Monthly Maximum Charge (MMC) in place, which is the maximum amount you’d pay each month in fees, charges and interest on unarranged overdrafts. It doesn’t affect authorised overdrafts, and the amount varies depending on the bank or building society, and which current account you have.

Make sure you check what the MMC is with your current account so you know how much your overdraft is costing you.

How to avoid overdraft fees

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

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

If you do go into your overdraft, there are some steps you can take.

Tips for controlling your overdraft

If you think you’ll go over your limit, talk to your bank and ask for a higher limit or an extension. You might be charged a fee, but it’ll be cheaper than the charges from an unarranged 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 incurring overdraft costs.

Making it easy to do is key:

  • download your bank’s app on your phone
  • set up text alerts if you have a low balance
  • use phone banking.

Consider asking your bank for help

Speak to your bank to increase your overdraft - If you need to extend your overdraft and have a good reason and a plan to repay it, 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.

Ask your bank to waive the fee - if you slip up and end up with a fee, ask the bank if they’ll cancel it.

If your bank won’t waive your fees, read our guide on how to Take action to reduce your debt.

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 fees.

Use savings if you have some

If you have savings as well as an overdraft, it’s cheaper in the long run to use your savings to pay off your overdraft instead of paying overdraft fees. 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 and shrink your overdraft fees, cutting back in other places will help you free up money. The money you save can then be used to pay off your overdraft.

Find some tricks and tactics for Living on a budget.

Switch banks

Switch to an overdraft-friendly bank account. Many banks offer interest-free, fee-free overdrafts from £100 to £300. You may even be able to switch to an account with a switching bonus which will help you to clear your overdraft.

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.

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