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.