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Overdrafts explained

How does an overdraft work?

published: 21 October 2021
Read time: 5 minutes

Overdrafts enable you to borrow money through your current account by spending more than you have available and going ‘overdrawn.’ Our guide explains how an overdraft works and the pros and cons

What is an overdraft?

An overdraft is a feature of most current accounts. It gives you the option to spend more money than you have in your account – this is called going ‘overdrawn.’ You’ll go into your overdraft if you make a purchase or withdraw cash that takes you below your available ‘in-credit’ balance – ending up ‘below zero’ or in debit.

An overdraft is a form of debt that you’ll need to repay and there may or may not, depending on the type of current account you have, be interest added on top. Some student current accounts come with an interest free overdraft for a number of years, for example.

While overdrafts can be a convenient way to borrow money short-term, they can charge high interest rates so make sure you check exactly what you’ll owe before you start using it.

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How do overdrafts work?

If you spend more money than you have available in your current account you’ll go into your overdraft - generally shown as a negative amount as your account balance. Once the bank agrees to the overdraft – this is known as your authorised overdraft. The bank will set an ‘agreed’ borrowing limit, such as £250 or £500 or up to £3,000 in some cases, depending on your financial circumstances and your credit rating.

It’s important to remember that an overdraft is a type of loan and a form of borrowing. Like all types of borrowing, make sure you’re confident that you can afford to pay back the money you’ve borrowed – and any interest it may accrue. That way you won’t run the risk of damaging your credit score or building up significant debts.

Depending on the type of overdraft you have, there may be expectations of when you’ll need to start paying off what you owe. For student current accounts, your overdraft is likely to be interest free and you’ll be expected to pay it back within two to three years after graduating. Banks can only charge you an annual interest rate for both unarranged and arranged overdrafts, meaning you won't pay any additional fees or charges - but entering an unarranged overdraft can negatively impact your credit score, so if you're looking to borrow, applying for an arranged overdraft is the better option for your credit rating.

How is an overdraft paid back?

Unlike a loan or credit card, overdrafts don’t come with a repayment plan so paying off the debt is entirely down to you. To pay off your overdraft, you’ll need to get your current account balance back above zero. Here’s some ways you could pay off your overdraft balance:

  • Use your savings: If you have money set aside in a savings account it could make better sense financially to use some of it to clear your overdraft particularly if you’re paying high interest on your borrowing

  • Transfer the balance: If your interest rate is high, you could use a money-transfer credit card to clear the debt built up in your overdraft. You may get a 0% interest period for 18 months in some instances

  • Switch providers: If you switch to a new bank, you could be offered an interest-free period on your overdraft for a set amount of time. This could help you avoid interest building up while you’re paying off your overdraft balance

  • Take out a loan: A low-rate personal loan could make paying off your overdraft more affordable, especially if the loan comes with a low interest rate

What types of overdraft are there?

Most current account overdraft facilities are divided into two groups, authorised and unauthorised:

Authorised overdraft

An authorised overdraft is arranged with your bank, and usually comes with an agreed borrowing limit – this can be anywhere from £250 to £3,000. While most banks will set up an authorised overdraft for free, in some cases – and often with business bank accounts - there may be a small arrangement fee

Unauthorised overdrafts

An unauthorised (or unarranged) overdraft is borrowing you haven’t agreed with your bank. You’ll go into an unauthorised overdraft if you go over your authorised overdraft limit or if you overspend when you don’t have an agreed overdraft with the bank. While lenders can’t charge you a higher rate of interest for going into an unarranged overdraft, there could still be negative effects associated with doing so, such as:

  • Negatively affecting your credit rating

  • Having payments like direct debits or standing orders bounce (known as returned items) as you don’t have the funds available. Some banks may charge an admin fee for this. If the payments were for debt repayment or utility bills this could also affect your credit score

  • You’ll be paying interest on more borrowing, so your debt costs will be higher

  • Some banks will ask that you repay any unauthorised borrowing within a short time frame, such as within the month

Am I eligible for an overdraft?

To be eligible for an overdraft, you’ll usually need to meet the following criteria:

  • Personal details: You must be aged 18 or over and a UK resident

  • No county court judgements: Most banks will ask that you have no county court judgements against you for the last few years (individual banks will specify how many years as policies will vary)

  • No bankruptcy: You’re not likely to be accepted for an overdraft if you’ve been declared bankrupt in recent years (terms and conditions will vary between current account providers)

  • No missed credit payments: Most banks will ask that you haven’t fallen behind with any credit payments or you’ve missed credit payments in the last few months

If you’ve struggled with credit in the past and have a poor credit score, you may struggle to be accepted for an overdraft. This is because your bank will have less evidence that you’re a reliable borrower. But this doesn’t mean an instant ‘no’ to securing an overdraft. Looking for ways to improve your credit score? Our credit monitor tool is a free, easy way to monitor your credit score – with helpful tips on how to improve it.

How much does an overdraft cost?

How much an overdraft will cost you will depend on the arrangement you have with your bank. You’ll usually fall into one of the following categories:

  • Interest-free: Interest-free overdrafts work like an interest-free loan, and you won’t face any charges for this borrowing. Some accounts offer an interest-free buffer on an agreed overdraft, usually up to £250, before implementing interest charges. Others, such as student or graduate accounts, might offer an interest-free agreed overdraft of up to £2,000

  • Agreed interest: If you’ve exhausted your bank balance and interest-free buffer (if you have one), your bank is likely to start charging you for using your overdraft at a set interest rate. In most cases it will be interest charged on the amount you’ve borrowed, though some may charge interest as a percentage of the full overdraft amount

Advantages and disadvantages of overdrafts

Undecided about whether to use an overdraft? Here’s some potential advantages and disadvantages to consider:

Advantages of overdrafts

  • Flexibility: Unlike a loan, where you’ll borrow a set amount and repay over a fixed period, an overdraft gives you a way to borrow the exact amount you need immediately and repay when it suits you

  • No early repayment charge: You shouldn’t be charged a fee for paying back any amount of your overdraft at any time

  • Quick to apply for: There’ll be less paperwork than applying for a loan – often you’ll get an overdraft automatically with your current account application

Disadvantages of overdrafts

  • Less money to borrow: The amount of money you can access through your overdraft tends to be lower than with a personal loan

  • Interest charges: The interest charged on overdrafts can be high, which can make it an expensive way to borrow long term

  • Over-spending: Spending is coming out of your current account so if you don't keep an eye on your debit card use you could end up with a large overdraft that's hard to pay off (most banks will send text alerts if you're close to your overdraft limit)

Should I use an overdraft or a loan?

Whether you should use an overdraft or a loan will depend on your personal, financial situation and what you’re looking to use the money for.

A loan can be useful for planned borrowing for a specific purpose, such as a car or home improvements, and then is paid back in monthly repayments. In contrast, an overdraft is a more open-ended borrowing facility. It is there for emergencies and should really be avoided for non-essential spending and purchases.

An overdraft could be a better choice if you’re looking to borrow a small amount of money for a short space of time, typically less than a month. It can work well if you need to access emergency funds. But try to look for an overdraft that won’t charge interest or fees.

While taking out a personal loan will typically give you access to a larger pot of cash and more time to repay the balance (depending on the term of your loan), you’ll need to make sure you can afford to pay it off.

It’s also worth considering other borrowing options such as a 0% credit card. If you are only looking to borrow a small amount – like £2,000 - you could consider using a 0% money transfer card which allows you to transfer money from your credit card into your current account and borrow interest-free for up to two years or more. Keep in mind that you will have to pay a fee to transfer the funds and make sure you clear your balance before the interest-free deal ends.

Does an overdraft affect my credit score?

Your overdraft, and more importantly the proportion of it you use each month, contribute to your overall indebtedness which in turn has an impact on your credit rating. Lenders look at your outstanding debts for example when making lending decisions.

Using an overdraft can affect your credit score – especially if you go beyond your agreed overdraft limit. This is because lenders are likely to see you as managing credit poorly if you struggle to clear your overdraft balance and regularly exceed your overdraft limit. If you were to enter an unarranged overdraft, this is likely to negatively impact your credit rating as it will indicate to lenders that you’re struggling to manage your finances.

If you have an arranged overdraft but don’t use it (or use it occasionally but clear it quickly) this shouldn’t affect your credit score. In fact, if you use your overdraft sensibly (and don’t exceed your overdraft limit) and regularly pay it off, it could actually improve your credit rating over time.

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If you're looking for a current account with an overdraft you can compare leading accounts with MoneySuperMarket. We can show you a broad range of accounts from across the market and searching won’t affect your credit score.

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