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Overdraft debt

Getting or increasing an overdraft - things to consider

If you're thinking of getting an overdraft, or increasing the one you have, it's worth thinking carefully before you do so. Overdrafts are an expensive way to borrow money, and you may want to consider whether there are cheaper alternatives. Here are some of things you need to think about.

What is an overdraft?

An overdraft is a facility attached to a current account that allows you to continue withdrawing money from your bank when your account has no funds in it.

Getting or increasing an overdraft – things to consider

Perhaps you’re considering getting an overdraft for the first time. Or perhaps you’re thinking about asking your bank to increase your overdraft limit so that you can borrow more. Whatever your situation, an overdraft is money that you’re borrowing from a bank. For this reason it’s important to consider whether you’re borrowing in the cheapest way possible.

Do I really need an overdraft?

Most banks offer an overdraft facility along with their current accounts. A simple rule to follow is that an overdraft should only be used as an emergency fund, or a short-term borrowing option.

The first question it’s worth asking yourself is whether you really need an overdraft. An overdraft is a debt – it’s money that you’re borrowing from your bank. Is there any way you could avoid this borrowing in the first place? Using savings, for example, if you have them, is a much cheaper way to top up your finances, because the amount you’ll be charged in interest on an overdraft comfortably outweighs the amount you’ll gain in interest from your savings.

How have overdrafts changed?

From April 2020, banks have changed the way they charge for overdraft use. Most overdrafts will be charged at a flat rate of around 40% EAR.

If you’re only an occasional user of your overdraft, and in small amounts, this will make using your overdraft a little cheaper. The Financial Conduct Authority (FCA) has ruled that lenders should ensure no customers are worse off than under the previous structure.

Even so, overdrafts are still an expensive way to borrow money, and you should look at other options much more closely.

What are my alternatives to getting or increasing an overdraft?

If you’re thinking of taking out any new borrowing, your first thought should be to make sure you’ll be paying the least amount of interest and fees possible. For this reason, it’s well worth considering the alternatives to getting or increasing an overdraft:

Use a comparison website to compare the different interest rates you’ll be paying on each of these compared to your overdraft rate, and then decide whether an overdraft is really the best (and cheapest) way for you to borrow what you need.

I don’t have a perfect credit rating. Can I still get an overdraft?

Your credit rating can affect whether a bank will offer you an overdraft. This means if your credit rating is poor, you may struggle to get an overdraft in the first place, or increase the one you have. Find out more about credit that's available for bad credit scores.

Can I rely on my overdraft?

Your bank can withdraw or reduce your overdraft at any time, without notice. This means it’s not the most reliable way of borrowing money. If you need a more reliable form of credit, you should look at other forms of borrowing, such as a credit card or personal loan

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What's the difference between an arranged and unarranged overdraft?

  • What's an arranged overdraft?

An arranged overdraft is one that you’ve agreed in advance with your bank. It’s subject to pre-agreed interest and fees.

  • What's an unarranged overdraft?

An unarranged overdraft is where you exceed this arranged limit. Your bank will immediately begin to charge you greatly increased interest and fees if you go into an unarranged overdraft. You should do everything possible to avoid this completely.

If you're depending on your overdraft, and regularly entering your unarranged overdraft, it could be a sign that you need help with debts.

The changes to overdrafts that will happen in April 2020 will effectively mean the end of unarranged overdrafts, as banks will no longer be able to increase interest and fees once you’ve reached your overdraft limit.

Does using my overdraft affect my credit rating?

If you frequently exceed your overdraft limit, or you owe too much on your overdraft, this can affect your credit rating. This can mean you’re less likely to be accepted for a loan, mortgage, credit card or other form of borrowing.

How can I reduce the amount I use my overdraft?

  1. Keep a careful eye on your account balance. Download your bank’s app on your phone, set up text alerts for low balance and use phone banking if you need to. That way you’ll know if you’re approaching your overdraft, and perhaps more importantly, whether you’re in danger of reaching the limit of your arranged overdraft. The FCA estimates that you are 24% less likely to receive unarranged overdraft charges if you use a mobile banking app and text alert service.
  2. Stick to your budget. This means creating a thorough and realistic budget in the first place. That way, you’ll be able to predict your spending, and you’ll know if there’s a danger of falling into your overdraft or reaching its limit.

Why does having an overdraft mean I need to read letters from my bank?

It can be tempting to ignore correspondence from your bank, or assume it’s just another statement. But your bank may write to you about your overdraft. So it’s really important you open all the letters you get from your bank.

Can I switch banks if I have an overdraft?

Yes, you can still switch banks if you’re in overdraft. You can switch using the Current Account Switch Service.

Need help with overdraft debt?

If you’re finding it difficult to manage your finances, or you’re struggling with debt, you may want to consider getting free, expert debt advice. We can help you set up a budget, take a look at your financial situation, and recommend possible debt solutions.