Pay Less For Your Overdraft!

Getting an overdraft from your bank can be a very expensive business. Although an overdraft can be a very flexible way to borrow, it’s repayable on demand, the interest charged is usually pretty high and you can be hit by additional charges of almost £40 a time.

The high level of these charges is being challenged by the Office of Fair Trading at the moment in a well publicised court case. If the OFT wins, we could see radical changes in the way we pay for our overdrafts.

Two types of overdraft

It’s important to understand the difference between an authorised overdraft and an unauthorised overdraft. The former is one you’ve agreed with your bank, and they may charge you an arrangement fee for the privilege. As long as you stay within this limit, the costs you pay shouldn’t be overly outrageous (the typical interest rate is 15% to 20%) but they vary significantly between banks. Bear in mind you could also be charged additional arrangement fees if you later want to increase your overdraft level.

It’s when you exceed the agreed overdraft level, and go into unauthorised overdraft territory, that the costs start to ramp up. The bank will decide whether or not to make any payment that takes you above your overdraft limit. If it decides not to, the item will repaid unpaid and you’ll be charged a fee. If the bank does pay it, you’ll usually get charged another fee and a higher rate of interest too, probably somewhere between 25% and 30%. The fact you’ve exceeded your overdraft limit will also get noted on your credit report potentially making it harder and more expensive for you to get other forms of credit.

Which overdraft facility works out cheapest for you is not always easy to predict. If you keep good control of your spending but do go overdrawn occasionally then a current account with low charges for planned overdrafts is a better choice. If your finances are prone to lapses then the charges for unauthorised borrowing could be more important.

Some banks have replaced interest charges on their overdrafts with fixed fees. For example, at the time of writing, Alliance & Leicester offered an account with an interest free overdraft for the first year, up to a maximum amount of £2,500. After a year, you’re charged 50p each day you’re overdrawn, up to a maximum of £5 a month. If you exceed your overdraft limit then the charge rockets to £5 a day plus charges per transaction.

If you ran an average overdraft balance of £1,000 over the course of a month then the £5 charge would only equate to interest of around 6% a year, which is exceptionally good value. Exceed your overdraft limit for a week or so, and you could easily rack up costs of £200 a month, depending on how many transactions are going through your account.

Lloyds TSB is another bank that’s changed its charging structure. It charges the same interest rate for authorised and unauthorised overdrafts but it also levies a £15 charge for any month in which you have an unauthorised overdraft plus a range of daily fees from £6 to £20 depending on how far you are overdrawn, with a maximum of 10 daily fees per month.

These changes mean it’s now a lot more difficult to compare one overdraft against another, but it’s generally become cheaper to have an authorised overdraft and more expensive to have an unauthorised one.

Warnings and grace periods

Part of the problem with the overdraft charges is that they often catch us unawares. You can check your balance regularly of course, and online accounts have made this much simpler, and you can keep a note of when payments are due to leave your account. Many people try to time payments so they leave their account a few days after payday to minimise the chance of there being not enough money in their accounts.

Banks have heeded some of the disgust levelled at the charges for unauthorised overdrafts though and taken some positive steps to help their customers. Some now offer a text service that warns you when you get close to your overdraft limit or give you a grace period of until 3:30pm the following day to pay funds into your account to bring you back below your overdraft limit. Other banks will let you go over your limit by £5 or £10 before making any charges or waive the fee for the first time you go above your limit in a certain period. Other accounts automatically offer interest-free overdrafts of a few hundred pounds. All this is helping and we’re likely to see more and more banks move in this direction.

Basic bank accounts

You can get one type of bank account that doesn’t allow you to go overdrawn. It’s called a basic bank account. You get a debit card for payments and cash withdrawals but no cheque book. You can also set up direct debits and standing orders, although you will still be charged if there is not enough money in your account to pay them and repeated failed payments could result in your account being closed.

Nevertheless, despite their limitations such accounts are a good way of reducing the amount you pay in overdraft charges. They can also help you improve your credit record and, as the minimum age limit for most of these accounts is 16, they can teach teenagers how to manage their money.
Student accounts and overdrafts

Banks try to lure students with all sorts of gifts but by far the most valuable is usually the interest-free overdraft. A new range of accounts is launched each summer and last year’s best offer was Halifax’s £2,750 overdraft, beating the competition by over £1,000. The full overdraft is often not available right from the outset but these offers are well worth pursuing.

Banks know that most people don’t tend to change our current accounts so they’re willing to lose a little money on us as students in the expectation that they’ll make a lot more off us in future!