Overdrafts allow you to borrow money when your current account is empty. This can help you bridge the gap between today and payday without turning to other expensive forms of credit.
Occasional use of an overdraft isn’t necessarily a bad thing, though the charges can be difficult to understand. Habitual use of your overdraft can become an issue though, if charges are eating into your income every month.
How are charges calculated?
There is no standard method of calculating charges for an overdraft. Some banks charge a daily fee, while others prefer to charge a monthly fee. Some banks calculate the charge using an interest rate instead.
An arranged overdraft is one that your bank has agreed that you can have. An unarranged overdraft is one that your bank has not explicitly agreed to. This will usually incur a much higher cost.
There are big differences between fees charged for the use of each.
If you think you need to use an overdraft, speak to your bank to arrange one as soon as you can. This way you can avoid the much higher charges that come from using an unarranged overdraft.
Can I get a free overdraft?
Some providers do offer free overdrafts. For example, First Direct’s 1st Account comes with a £500 overdraft, £250 of which is interest-free. Other accounts offer interest- or fee-free deals for a certain period. Nationwide’s FlexDirect account, for example, offers a 0% overdraft for the first 12 months.
These are arranged overdrafts, so you will need to apply for them. It is up to the bank to accept that application too.
The ‘buffer’ zone
Most large retail banks offer a small free overdraft facility to customers. This is often referred to as a ‘buffer’.
This means that if you’re not that far into the red, the bank won’t charge you for using the overdraft. The buffer usually extends to about £10 or £15. Check if your account offers this before going overdrawn.
What are the alternatives to an overdraft?
You may find that using an overdraft is more expensive than borrowing using a credit card. If you have almost run out of money in your current account, consider using a credit card for a while. This is a good tactic if you have a card that offers a 0% period on spending.
You should not use a credit card to fund purchases that you will later struggle to make the payments for. But if you need a little extra to tide you over until payday, this could be the answer. Consistent use of an overdraft can be very costly.
Minimum payments should always be made on time. Ideally, you should always pay off any credit cards in full before the lender charges interest.