Most current accounts come with an overdraft facility these days, either one that you have to apply for or it's included in the package.
But should you use it? How much is it going to cost you? How do you compare? We've looked into it so that you don't have to.
An overdraft is a feature of your current account that allows you to continue spending even once you’ve exhausted all your available funds.
Since you’re effectively borrowing money, you’ll usually be charged interest and/or a fee for it. Overdrafts can turn out quite expensive, with many account banks charging around 40% annual interest rates, making borrowing more expensive than via some credit cards.
Some banks offer a 0% overdraft in order to entice new customers in, but this ‘free’ borrowing facility usually last for a fixed period. For example, new Nationwide FlexDirect account customers can take advantage of a 0% for a year, subject to certain terms and conditions.
So you should only use yours in case of emergency. However, they can be handy if you need just a few extra quid to make it to the end of the month.
Arranged overdrafts. That’s when you are approved for an overdraft. You’ll be able to borrow up to a set limit.
Unarranged overdrafts. That’s when you haven’t agreed to an overdraft with your bank and still overspend, or when you spend more than your overdraft limit.
How to apply for an overdraft
When you open a current account, many banks will give you the option of an overdraft. You can apply for it then or later on.
You can typically apply for an overdraft online or from your banking app. You’ll be asked what arranged overdraft limit you’d like and will usually be credit checked. If you pass (the credit limit you’re approved for may be lower than what you asked for), you’ll then be able to use your arranged overdraft.
Overdraft fees
As we said, before using your overdraft, you should make sure you’re fully aware of how much it’s going to cost you. There are different fees to take into account and they can quickly add up to a fairly significant sum.
In April 2020, the government brought in major changes to the costs of overdrafts, meaning that banks cannot charge higher fees for unauthorised overdrafts, as used to be the case.
This means that interest on all overdrafts is charged at a single annual percentage rate (APR). The idea is that this makes it easier to compare charges between accounts.
Fees for accessing an overdraft facility. This isn’t super common, but with some banks, you’ll be charged just for having an overdraft facility on your account, even if you don’t use it.
Fees for using overdrafts. You’re typically charged an interest rate levied on the amount you borrow, but this varies will vary from bank to bank, so make sure you check exactly how much you would owe, and over how long a time period, before dipping into your overdraft.
Is a current account with an overdraft a good idea?
In theory, there’s no harm in at least applying for an overdraft facility and having it on your bank account. It can be a life saver if something happens and you have to deal with an emergency. However, if you do it, you need to be aware of the catches:
It can be an expensive form of borrowing. Depending on the interest rate your bank offers, the interest can add up.
Be especially careful if you have more than one current account. If you spread your money between different accounts, you may accidentally end up using your overdraft even if you don’t actually need it.
Ultimately, it all comes down to how much your bank charges. There are current accounts out there offering decently priced overdrafts that can be really helpful if you need a bit of extra cash at times.
An overdraft can be a handy safety net, but keep a close eye on the costs so the debt doesn’t get out of control.”
Can you switch current accounts with an overdraft?
Yes, you can. Having an overdraft won’t stop CASS (the current account switching scheme) from doing its thing and transferring your direct debits and payments to your new bank while closing your old account. If you had an overdraft with your old bank but weren’t using it, you don’t have to do anything except apply for an overdraft with your new bank if you still want it.
Things are a tad more complicated if you were using your overdraft and your old account was in debt. You have two main options:
See if your new bank will accept your overdraft. If it does, you’ll be able to transfer it directly from your old account. Just make sure you’re not getting yourself a worse deal.
Pay off your overdraft. If your new bank doesn’t agree to transfer your old overdraft, you’ll have to pay it off. Get in touch with your old bank to agree on how to do so. If money is tight, keep in mind that your new bank may still be willing to offer you an overdraft even if it doesn’t allow you to transfer your old one (it’s worth asking/applying).
If you’re looking for a bank account with an overdraft, it’s important to consider how often you’re likely to use your overdraft and how much you’ll be charged for doing so.
Some bank accounts will offer an interest-free overdraft for the first 12 months, for example, which could be a good option if you only need it for a set period, or you have an existing overdraft you need to pay off.
Others, however, will offer a small interest-free buffer to act as a safety net as and when you need it. If you are likely to go over this buffer, make sure you compare exactly how much you’ll be charged for doing so and look for the most competitive option.
Alternatives to overdrafts
Overdrafts are definitely not your only option when it comes to borrowing:
Credit cards. If you often end up overspending one month only to make up for it the following one, getting a credit card can be much better than dipping into your overdraft. As long as you clear your balance in full every month, you won’t be charged any interest.
Personal loans. If you already know you’re going to have to borrow money in the near future, or are looking to fund a medium-to-long-term project, there’s really no point in relying on your overdraft. A personal loan will probably be more suitable for your needs.
Finally, if you find yourself overusing your overdraft, maybe the time has come to do a bit of budgeting and reorganise your finances. If it sounds like a daunting task, why not try a budgeting app?
Pros and cons of a bank account with an overdraft
Pros
Some overdrafts are interest-free up to a set limit.
If used sensibly, an overdraft can help improve your credit score.
Overdrafts are flexible, allowing you to borrow what you need when.
Overdrafts are quick to arrange.
There is no set repayment term.
Cons
Interest rates can be high and you might be charged fees on top.
If you regularly exceed your overdraft limit, this can negatively impact your credit score.
Your overdraft is not guaranteed and can be cancelled at any point.
Borrowing limits are usually lower compared to other forms of credit such as credit cards and loans.
Bottom line
An overdraft can be a handy addition to your bank account and can offer a valuable safety net in the event an unexpected payment pushes you into the red, for example. Applying for an overdraft is usually straightforward and there are a few low cost options available.
However, it’s important to stay within your overdraft limit and try to pay back the amount borrowed as soon as possible. Otherwise, the more you rely on your overdraft, the harder it will become to get out of it.
Frequently asked questions
Yes, many banks will allow you to switch accounts even if you're overdrawn. You're likely to find it easier if you have a good credit score and you've stayed within your overdraft limits. Many banks will also match your existing overdraft limit, provided you have proof of the amount.
Yes, your bank can remove your overdraft at any point – it is not guaranteed. However, if your bank cancels your overdraft without warning and you are charged as a result, you might have grounds to complain.
The amount of interest charged will depend on the account – interest rates can range from 0% up to 39.9%. For this reason, it's crucial that you shop around carefully.
If you need to borrow funds, you could consider a 0% purchase credit card that will allow you to spread the cost of your spending interest-free for a set number of months. Be sure to clear your balance before the 0% deal ends and interest kicks in.
If you need to borrow a larger sum, a personal loan will likely be the better option. Personal loans allow you to borrow a pre-agreed sum of money to be repaid over a number of years – usually between one and seven. Monthly repayments are fixed with interest charged on top.
Look for an account that only gives you one if you apply for it (there are plenty). But make sure you're aware of what happens if you overspend – you're usually charged a fee if a payment is refused due to lack of funds.
Yes, as you are borrowing money from your bank, an overdraft will affect your credit score in the same way as any other form of borrowing. An overdraft will appear on your credit report as a debt, which means lenders will be able to see you have an overdraft, along with how much of it you are using.
Providing you don't exceed your overdraft limit and you regularly pay it off, it shouldn't have a major impact on your credit score. In fact, if used sensibly, it could actually improve your credit score as it can indicate to lenders you are a reliable borrower.
However, if you regularly go over your overdraft limit, your credit score could be negatively affected as it could suggest you're struggling financially. Learn more about overdrafts and credit scores.
Following a rule change in April 2020, banks can only charge a flat rate of interest on overdrafts, and they can no longer charge monthly or daily fees. They are also no longer able to charge more for unarranged overdrafts than arranged overdrafts.
The rules were introduced to make it easier for customers to compare overdraft interest rates between providers and to remove the very high fees being charged on unarranged overdrafts.
The size of your overdraft will depend on a range of factors including your credit limit and your income and outgoings. The better your credit score and the more you earn, the higher your overdraft is likely to be.
If you are offered a smaller overdraft than you would like, you may be able to extend it after some time, providing you have managed your bank account sensibly.
Some bank accounts offer a small, interest-free overdraft limit known as a buffer. These can be handy if a payment unexpectedly and temporarily takes you into your overdraft, for example, as you won't be charged interest on the amount borrowed.
Interest-free buffers can be as low as £15, or they can stretch up to £2,000, depending on the bank.
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Valentina Cipriani was a writer at Finder UK. She wrote news, features and guides about banking and credit cards, helping people to improve their financial lives. She holds an MA in International Journalism. See full bio
Rachel Wait is a freelance journalist and has been writing about personal finance for more than a decade, covering everything from insurance to mortgages. She has written for a range of personal finance websites and national newspapers, including The Observer, The Mail on Sunday, The Sun and the Evening Standard. Rachel is a keen baker in her spare time. See full bio
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