Examining the ins and outs of overdrafts

       

Mo Saffaf

Utilising your overdraft facility should be a short-term borrowing solution and ideally only reserved for emergencies. Ultimately going into your overdraft means that you are incurring debt. It is critical that you treat your overdraft as you would any other form of debt e.g. online loans to ensure you are not overwhelmed by recurring and increasing fees and interest charges.

At 247moneybox.com we have prepared the following guide examining overdrafts in order to give you a more holistic picture about how they work and whether they are the most appropriate solution for your borrowing needs.

How do overdrafts work?

There are certain bank accounts called "fee-free" accounts for people with poor credit scores that do not offer an overdraft facility. However, most current accounts usually offer the option for you to borrow money through an overdraft for a fee. Some current accounts will have this set up automatically, but you are able to request for this add on if not. The bank will base their decision on the provision and amount of overdraft on your financial health, credit score and general activity. An overdraft is effectively a loan that is easier to arrange, but it's essential that you bear this in mind when evaluating the cheapest option for your borrowing needs.


man holding piggy bank

There are various types of overdrafts available in today's market. Authorised or arranged overdrafts, for example, are typically in advance. The bank sets a borrowing limit that is agreed by both parties. Within this limit you are able to use your debit card and make bank transfers, so all of your standard payment options are still available as normal. These do typically come with fees or interest so please consult your bank about their specific rates.

Unauthorised, unarranged or unplanned overdrafts occur when you spend more than the amount the bank has agreed with you, whether you have an overdraft set up or not. Of course the same applies when going over the overdraft limit set by the bank too. In either case this can result in very high additional fees and interest so please be aware of this and again consult with your bank for specific rates.

Is an overdraft necessary for you?

Using a budget planner to help manage your money more effectively is the first step to take if you find yourself regularly utilising your overdraft. Having an authorised overdraft can be quite useful, particularly if your bank balance doesn't have the funds to cover any bills, direct debits or unexpected outgoings. It can be an important option for emergencies and/or as a solution for short-term borrowing, but it should always be treated as such.

According to the Financial Conduct Authority (FCA), overdrafts are used more regularly than they should be because people assume it is cheaper than other forms of borrowing or does not incur any fees whatsoever.

Charges for using arranged overdrafts

Charges for arranged or authorised overdrafts vary from bank to bank, which is why we recommend you contact yours to get a definitive breakdown. The charges are typically comprised of a set fee that is charged daily, weekly or monthly whilst you remain in your overdraft. Some overdraft facilities add further interest charges which will again vary depending on the bank.



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Daily fees can be quite costly, particularly as they don't take into account how much you've gone into your overdraft. You could be paying a flat fee for only going a little overdrawn which is not an economically efficient method of borrowing.

There are certain banks that offer an interest-free overdraft with a limit. To learn of the costs of going overdrawn at your particular bank, we'd recommend calling them to ask for a breakdown; to check their website for any further details; or to consult the terms and conditions on their printed leaflets - which are typically sent to you once you open an overdraft facility.

Find a more suitable current account

As previously mentioned, using an overdraft can be a very expensive long-term borrowing solution, particularly if you have the wrong account for your financial needs. It is worth noting that some banks do offer interest-free overdrafts that apply to a small limit, e.g. up to £300, or to overdraft facilities set up on student bank accounts.

There is plenty of information on comparison websites that can aid your search to find a bespoke account for you. Please note you are able to switch accounts even if you are withdrawn with your current account.


calculator, pen and paper

Unarranged or unauthorised overdrafts

An unauthorised overdraft is the term used to describe what happens when you surpass the overdraft limit agreed with your bank. It also applies if you don't have an overdraft facility agreed and spend funds that are not available in your account.

This can prove very costly and it is recommended that you avoid this as a borrowing option, as you will incur a wide variety of fees and charges. For example, these can be flat daily and monthly fees, sometimes as high as £35 for the latter, although daily fees are typically limited to a point. There are also transaction fees, sometimes up to £25, that apply to any cash withdrawals or direct debits that go over this limit that do not guarantee that the money is withdrawn/sent despite the fee being charged.

A Monthly Maximum Charge (MMC) is now standard across current accounts in order to protect people from accruing large monthly interest and charges by setting a limit on the amount the bank can legally charge you for an unauthorised overdraft. Do bear in mind that this does not apply to authorised overdrafts.

Tips to avoid incurring overdraft fees

Much like any loan it is very easy to get sucked into a cycle of debt by using an overdraft facility regularly, particularly if you are incurring consistent fees and charges thereby forcing you to dip back into your overdraft the following month. The FCA suggests use of a mobile banking app, as well as setting up a text alert service, which can reduce the likelihood of incurring overdraft fees by 24%. This is primarily because an app or alert can help you track your spending thus keeping you aware of how far you are to your limit.

You may be able to arrange something with your bank if you think you will exceed your limit. They may be able to increase your limit or in some cases offer a longer-term debt solution. Even though an increase in your arranged/authorised overdraft will still accrue fees and charges, these will be far smaller than going into an unarranged/unauthorised overdraft.

You should make your bank aware of your situation prior to going in the red. If you have a valid reason, a good history with them and an idea of how you are planning to repay the balance over your overdraft limit, they are far more likely to be reasonable and sympathise with your situation than if you are to contact them after going over your limit. In some cases, they may even waive off any fees in good faith that you have told them in advance, but it is quite common for the bank to temporarily increase your limit regardless upon consultation.

Additional tips to avoid incurring overdraft fees include:

Many people don't have the luxury of a savings account, but if you do have one in conjunction with an overdraft facility, then it's advisable to use money from your savings to cover your overdraft as it will work out much more cost-effective in the long-term. In this way, you still have your overdraft to cover any unplanned or emergency expenses with the option to continue building your savings, thereafter, saving you accruing overdraft fees and charges in the process.

Budgeting is essential if you are to lower your outgoings and therefore reduce your dependence on your overdraft, which will inevitably reduce fees and charges in the long run. There are a large number of apps and budget calculators that can make it a lot easier for you to get a sense of your budget and ensure you stick to it.

Consult with your bank immediately and directly if you feel that you have been charged unfairly by the bank. In many cases, you will be able to reclaim any funds if you can prove they are excessive or that you are struggling financially. You should also consult the Financial Ombudsman Service (FOS) or Citizen's Advice Bureau (CAB) should you wish to take further action or have a legitimate dispute you would like guidance on.

Your bank has complete autonomy as to whether it offers you an overdraft facility or not, which means that it can legally close your overdraft with little warning. This is one of the key reasons why having an overdraft is not a sensible and sustainable solution for long-term borrowing.

Conclusion

As we have examined there are pros and cons to having an overdraft facility available to you. Ultimately it is up to you to decide whether it is suitable for your personal financial needs or if a different form of borrowing could be more suitable e.g. a payday loan.