How to manage an overdraft
Is your current account often in the red? We explain how the banks calculate their charges and what you can do to cut them.
Most of us stumble into the red at one stage or another, but for those who haven’t arranged an overdraft with their account provider, the results can be seriously bad for their wallet.
Even using an authorised overdraft of £500 for one month would accrue a monthly charge of £30 at Halifax, while Santander would charge £6 a day up to £95 a month.
Kevin Mountford, MoneySupermarket’s head of banking, says: "While turning to an authorised overdraft may be a good option for some, fees and charges on bank accounts do vary considerably. So if you dip into your overdraft often, it is worth making sure the account you are using is suitable for your needs."
There are two types of overdraft: authorised and unauthorised (sometimes referred to as arranged and unarranged). With an authorised overdraft, your bank agrees to lend you money to cover your overdraft. An unauthorised overdraft is one where your bank has not approved you straying into overdraft territory.
When you are overdrawn, you are borrowing money - and can expect to pay for the privilege. Typically, the fees for unauthorised borrowing are much higher, so it's wise to keep track of your balance.
You should think of getting an authorised overdraft if, by the end of each salaried month you are frequently ending up overdrawn or your account is near empty.
But it is also important to remember that an overdraft is merely a safety net to stop you incurring even larger charges, and you should not be using it for long-term borrowing.
What charges will I be hit with?
On arranged overdrafts, the charges you can be hit with include a monthly or even daily fee, as well as interest on the amount you have gone overdrawn.
The Money Advice Service (MAS) says authorised overdraft fees incur typical interest of around 15% to 20% EAR, plus a monthly fee of £5 to £35, with some banks charging daily fees of around £1 to £2.
If you continue to spend on your account, you could also be hit with transaction fees of £10 to £25 per withdrawal, direct debit transaction or card payment.
Andrew Hagger of moneycomms.co.uk warns: "Some accounts charge a daily fee for going overdrawn rather than interest - with Halifax and Santander charging £1 a day and Nationwide FlexDirect 50p a day. This type of overdraft may be easier to understand but can be expensive for smaller overdrafts - a one-day charge of £1 on a £500 overdraft is the equivalent interest rate of 73%."
Charges on unauthorised overdrafts are extremely high and increase daily, in many cases. Hagger adds: "You should avoid unauthorised overdrafts if at all possible as the costs can soon mount up - for example, with Lloyds TSB you'll be charged a £6 monthly fee, plus if you're more than £25 overdrawn you'll pay £10 a day until it's cleared (up to a maximum charge of £80 a month)."
How to manage your overdraft
Having an overdraft can lead to high charges and interest, so you need to know how best to manage it. First of all, you should always ensure you know your limit.
Ensure that you keep track of how much you're spending and how much you have in your account. You can do this by creating your own budget planner, detailing your expenditure. Also, many banks offer a text alert service, which sends a text message to warn you that you are close to passing your overdraft limit.
If you are going to pass that limit, speak to your bank. Under the lending code, banks have a duty to be sympathetic to your situation. The MAS recommends: "If you need to extend your overdraft and have a good reason, then your bank is likely to be sympathetic - as long as you let it know in advance."
Only use your overdraft for short-term borrowing or emergencies and try and avoid remaining overdrawn month to month. "One reason that an overdraft isn't safe for long-term borrowing is that it's not guaranteed," adds MAS. "The bank could withdraw it any time and leave you without the cash you thought you had access to."
Most importantly, make sure you have an overdraft-friendly account, because they tend to have lower charges and can potentially be fee-free, to a limit.
Nancy Baynes of the MAS says: "Overdrafts can give you a handy financial cushion, and it is possible to use them safely - but slipping into an unauthorised overdraft can leave you with expensive fees you may not be able to afford. The trick is to stay aware of your overdraft and keep on top of your money."
What accounts are best if you're always overdrawn?
You'll need to choose an overdraft-friendly bank and avoid unauthorised borrowing. Kevin Mountford of Moneysupermarket says: "If you regularly go overdrawn, subject to how far in the red you go, I'd recommend a product with a free buffer or something that has a low cap. One thing for certain is you need to secure an 'approved' overdraft; unauthorised borrowing costs a fortune."
Among the major high street players, First Direct's 1st account is currently the best for authorised overdraft facilities. There is no fee and if you go into the red, you won't face a charge for overdrafts up to £250. If you go above this, you will be charged 15.9% EAR. On an authorised overdraft of £250 for seven days, this account would not cost you anything.
The next cheapest is Nationwide's Flex account, with no monthly fee and interest of 18.9% EAR. A £250 overdraft would cost 91p over seven days.
At the other end of the spectrum, the Select Account, from RBS and NatWest, fares worst for overdrafts on the high street, charging £6.62 if you’re overdrawn by £250 for five days.
The Classic Account, from Bank of Scotland, Lloyds or TSB, and the Current Account Plus from Yorkshire Bank and Clydesdale Bank also charge more than £6 to borrow £250 for five days, while Santander's 123 and Everyday, and Halifax's Reward accounts all cost £7 for a £250 overdraft if you’re overdrawn every day for a week.
Avoiding overdraft fee
- Stay within your limit to avoid added fees.
- Don't ignore fees and charges - they can mount up.
- Check payment timings - if any regular payments go out of your account just before payday, change them to just after payday, if possible.
Budget sensibly to try and haul yourself out of an overdraft scenario.
An overdraft is an agreement with your bank that authorises you to withdraw more funds from your account than you have deposited in it. Many banks charge for this privilege either as a fixed fee or charge interest on the money overdrawn at a special high rate. Some banks charge a fee and interest. And other banks offer a free overdraft but impose very high charges for exceeding the agreed limit of your overdraft.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.