We hear about overdrafts a lot – so much so it’s easy to forget they’re just another form of debt. Yet if you only occasionally need to borrow small sums, they can be one of the best ways to do so.
What is an overdraft?
Overdrafts are a short-term solution to borrowing money. They’re provided by your bank and added onto your account. Unlike loans, you can borrow and repay money as and when you need to. Check our guide for more information on the differences between personal loans and overdrafts.
Some overdrafts offer competitive rates of interest; others less so. Therefore, in the same way that you would compare loans, you should likewise look out for rates of interest for overdrafts.
How do overdrafts work?
When your bank balance reaches zero, one of two things might happen. Either, your payments bounce – that’s it, no more spending. Or, you can continue borrowing money, taking your balance into the negative. This is an overdraft.
‘Authorised overdrafts’ are ones which are arranged between you and your bank. You’ll be able to borrow money up to a pre-agreed limit for which you’ll pay interest. By contrast, ‘unauthorised overdrafts’ are unplanned, so you might go overdrawn without an agreement being in place between you and your bank; the same goes for if you were to surpass your overdraft limit.
You’ll be charged interest either daily or monthly every time you use your overdraft.
What overdraft limit can I get?
Overdrafts can range from a few pounds to several thousand pounds, but most commonly banks offer around £500. Some banks will just always have higher limits than others, too.
If you’re specifically looking to borrow larger amounts though, then you should be aware of two things. First, your limit will likely depend on your credit history – if you have consistent income you may be able to borrow more. Secondly, overdrafts are a good solution to short-term borrowing of small amounts only. If you need more, you should look at a personal loan – more on this later.
New overdraft rules
In April 2020, new overdraft regulations were brought in by the FCA to better serve consumers. All fixed charges for overdrafts have been stopped and you’ll now only be charged interest.
Bans on both daily and monthly overdraft fees have been introduced, as have fees for simply choosing to have an overdraft available, regardless of whether you use it. In addition, all overdraft prices must advertise APR as mandatory.
Last, banks are also obligated to take further measures to identify those who may be in financial distress and help them with their overdraft use.
Beware these changes, banks were also able to charge higher fees for unauthorised overdrafts but they’re no longer allowed to do so. However, if you do enter an unplanned overdraft you may find this negatively impacts your credit score.
Overdraft fees and charges
So, banished are the additional fees and charges for simply being in your overdraft. You will however have to pay interest, which may be charged either daily or monthly depending on your deal. There are a few exceptions to this though: for example, many student overdrafts are interest-free, or part of your deal may be having an interest-free introductory period.