What is an overdraft?
An overdraft is a feature of many current accounts, which lets you spend more than you have in your account at the time, effectively by borrowing it from your bank.
How does an overdraft work?
If any money leaves your current account after the balance hits zero, you’ll enter your overdraft – it generally shows as a negative amount on your account balance.
What types of overdraft are there?
Most current account overdraft facilities are divided into two groups, authorised and unauthorised:
- An authorised overdraft is what you arrange with your bank, and usually comes with an agreed borrowing limit – this can be anywhere from £250 to £3,000
- Unauthorised overdrafts aren’t arranged with your bank. You’ll go into an unauthorised overdraft if you spend more than what’s in your account without agreeing with your bank beforehand
How much does an overdraft cost?
Currently the cost of entering your overdraft depends 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 entering it. Some accounts offer an interest-free buffer, usually up to £250, before implementing charges, while others like student or graduate accounts offer an interest-free 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
- Regular fees: The alternative to being charged interest on the amount you’ve borrowed from your overdraft is a flat fee set by your bank – for example, £1 a day for every day you’re overdrawn
But the way banks apply charges is going to change in April 2020 as a result of new laws brought into place by the financial conduct authority.
Why might I need an overdraft?
An arranged overdraft can be a safety cushion for small unexpected outgoings – minor car or home repairs, for example. They let you spend extra when you need to, though you might have to pay interest or a fee, and help tide you over until payday.
What changes are coming to the way overdrafts work?
Starting from 6 April 2020, new rules set out by the FCA will mean banks can only charge a single annual interest rate for both arranged and unarranged overdrafts – a change, they say, that will positively impact seven out of 10 overdraft users.
How do I get an overdraft?
When you apply for a current account, in some cases you’ll automatically be given an authorised overdraft. If not, you’ll need to request one – but you might not get the amount you asked for.
Do I need an overdraft?
An overdraft facility could be a good option for short-term borrowing – around one or two weeks – as they generally offer more flexible repayment options than alternatives like loans or credit cards. However as a result of the changes due to take place in April, long-term overdraft users may find the new costs outweigh the benefits.
Therefore you may want to consider other forms of borrowing – such as:
- A credit card: Credit cards let you spend money on credit – essentially borrowing it from your lender and paying it back every month. However there are usually interest rates attached – especially if you don’t make your full repayments
- A personal loan: Personal loans are sums of money you borrow from a lender and pay back over a period of time, again usually with interest
Both of these options work differently to overdrafts, and each come with positives and negatives you should consider before making your decision.
If you’re already in your overdraft and you want to get yourself out, read our guide to paying off your overdraft for some helpful advice.
Who qualifies for an overdraft?
Whether you qualify for an overdraft will depend on your bank’s own criteria, but most current accounts will offer some kind of overdraft facility.
This won’t apply, however, if you’ve got a poor financial history – in this case, you might only qualify for a basic bank account. These are designed to help people rebuild their credit history, and they generally don’t come with an overdraft at all.
Does my overdraft affect my credit score?
Your overdraft – and the proportion of it you’ve used – contribute to your overall credit utilisation ratio, which does affect your credit score. The credit utilisation sweet spot is around 30% – meaning you’ll ideally use around 30% of the credit available to you and regularly pay off what you owe.
Any more than that and it will imply that you’re going through financial difficulties – negatively impacting your credit score and making it less likely you’ll be able to apply for loans or credit cards.
You can keep an eye on your financial history and see how it affects your score with our credit monitor, so you can take the steps towards improving your score.
Compare overdraft current accounts
MoneySuperMarket’s current account comparison tool lets you compare overdraft offers from a range of banks and building societies.
Save money by finding the right overdraft account for you today.