You might occasionally dip into it, live at the end of it or be somewhere between the two, but if you have an overdraft you need to read this article. It may well turn out you know a lot less about your debt than you realise.
They can be very expensive
When you think of expensive borrowing the first thing that is likely to pop into your head is payday loans, but many overdrafts are far more expensive than a payday loan.
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In some cases an overdraft can cost you 12 times as much as a payday loan, according to research by Which. They compared the cost of borrowing £100 for 28 days and found banks were charging as much as £90, whereas the maximum a payday lender can charge since new rules were introduced in 2015 is £22.40.
That doesn’t mean turn to payday loans though, as they can have a terrible effect on your credit rating. Instead make sure you understand your bank’s overdraft charges and if they are high switch to a cheaper bank - and of course aim to try to get yourself back in the black sustainably as soon as possible.
There are two types of overdraft
If your account has fallen into a negative balance then there are two different types of overdraft you could be using: authorised and unauthorised. The first one is when you have an overdraft set up on your account that has been approved by the bank.
The other is a far more expensive borrowing facility where some banks will allow you to go into the red even when you don’t have an overdraft, or they will allow you to borrow more than your overdraft limit up to a set amount. This is an unauthorised overdraft and many have eye-watering charges. One of the worst offenders is Lloyds, which charges an astronomical £10 a day if you go more than £25 into an unauthorised overdraft and also charges up to £30 a day for "bounced" payments.
Santander’s popular 123 account also stings with charges of £6 per day for unauthorised overdrafts.
These charges are now changing as a result of new rules brought in by the Competition and Markets Authority, with banks having to set a monthly charges cap. Most are between £80 and £95. Lloyds is ditching its charges altogether in favour of a simpler interest rate of 1p per day per £7 borrowed on any overdraft, but that's still an annual rate of 52 per cent per year.
Don’t take your overdraft for granted
Your bank is allowed to cancel your overdraft at any time and call in the debt. You may receive a letter from your bank saying that your overdraft agreement is due to expire and you need to reapply. If your credit rating has fallen since you initially applied for your overdraft you could find your new application rejected and your bank asking you to repay the debt.
The FCA is no fan of overdrafts
The Financial Conduct Authority (FCA) has launched an attack on overdrafts. It is considering banning charges on unauthorised overdrafts as a result of an investigation into the high-cost credit market.
“We believe there is a case to consider fundamental reform of unarranged overdrafts, and whether they should have a place in any modern bankingmarket,” said the FCA report.
“Maintaining the status quo is not an option,” says FCA chief executive Andrew Bailey.
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