How often do you find yourself dipping into your overdraft to get by?
An overdraft can be a safety net, but for many they are an unsuspecting, slippery slope that leads to debt.
What masks as a quick, easy and short-term solution for when life throws an unexpected curveball at you (and your finances) can quickly spiral into years of debt and interest repayments and charges and poor financial wellbeing. And we all know that life loves a curveball...
With the UK owing £6.4 billion in overdrafts (Apr 2019) and UK banks and building societies making over £2.4 million in 2017 from overdraft charges and interest, it’s clear that there’s a good reason for financial institutions to keep their customers in the red.
So, how can you tell if you rely too heavily on your overdraft? And if you do, how do you go about paying it off?
What Is An Overdraft?
An overdraft is an extension of credit to your bank account which gives you access to more money than you have in your account. This extension will be agreed and approved by your bank.
Although overdrafts have become the norm, they are still a form of debt and often have high interest rates, charges and fees applied to use them.
There are two types of overdraft that come with different fees and charges.
Arranged or Authorised Overdraft
An arranged overdraft will be an agreed amount of money authorised by your bank to allow you to spend more money up to a limit.
Usually arranged overdrafts will charge you interest for using the credit, but there won’t be any additional fees or charges.
Unarranged or Unauthorised Overdraft
An unarranged overdraft is when you go over the limit that has been set by your bank - whether that’s over your arranged overdraft or simply more than the amount of money you have in your bank.
When you go over your limit without the bank’s permission additional charges fees and interest will be added - which makes an overdraft a very expensive way to borrow money.
Is It Good To Have An Overdraft?
Having an overdraft is seen as an entitlement, a perk of a bank account or a life-line but it could become a drain on your money if used recklessly or relied upon.
Charges rack up, your overdraft eats into your next paycheck, you're not gonna make what's left stretch for the rest of the month.
Suddenly, going over your overdraft is a normal monthly occurrence.
“It’s like a black hole! I’m not at all clear about it… the rules aren’t clear, what makes you eligible? How do they decide?” anonymous, FCA 2019 report.
Often overdrafts are approved and granted to customers without any strict affordability checks. Worse still, banks have been known to increase overdrafts without asking, sending users even further into debt whilst masking as a benefit to a bank account.
Overdrafts can be a benefit. When used as a safety net when unexpected expenses creep up, the overdraft is a common way of absorbing financial shock.
But when you look at the statistics, when you see how much banks profit from customers relying on their overdraft, and how many people are stuck in a cycle of trying to pay it off - you realise that an overdraft is a means to make money out of the financially vulnerable.
So, if you have incredible self-control and have always been able to pay off your debts quickly - perhaps an overdraft is a worthy solution.
However, if you’re prone to impulsive spending or overspending an overdraft can keep you in debt and make you feel like you’re not.
What Does The FCA Say About Overdrafts?
After extensive research, the Financial Conduct Authority have announced a new set of regulations to set a new standard when it comes to arranging and charging for an overdraft.
The FCA has confirmed that the following regulations will come into effect in 2020:
- Stopping banks and building societies from charging higher prices for unarranged overdrafts than for arranged overdrafts.
- Banning fixed fees for borrowing through an overdraft – calling an end to fixed daily or monthly charges, and fees for having an overdraft facility.
- Requiring banks and building societies to price overdrafts by a simple annual interest rate.
- Requiring banks and building societies to advertise arranged overdraft prices with an APR to help customers compare them against other products.
- Issuing new guidance to reiterate that refused payment fees should reasonably correspond to the costs of refusing payments.
- Requiring banks and building societies to do more to identify customers who are showing signs of financial strain or are in financial difficulty, and develop and implement a strategy to reduce repeat overdraft use.
How To Get Out Of Your Overdraft?
If you find yourself constantly dipping into your overdraft to get by month to month, or worse still you go over your overdraft, you need to create a plan to pay it off and get out of debt.
If you haven’t already tracked your spending and created a budget, this is the best place to start. Make sure you note everything coming in and everything coming out of your account - including any charges.
From this you should be able to see where it could be possible to make sacrifices in order to pay off your overdraft. Ultimately, the quicker you pay it off the less charges you’ll face and the more money you’ll have on a monthly basis.
If you have combined high-interest debts it could be beneficial to take out a peer-to-peer loan in order to consolidate your loans, overdrafts and credit cards into one monthly repayment at a comparatively low interest-rate. Use our free loan calculator to see how much interest you could save.
If your debts and your overdraft are leaving you feeling overwhelmed then there are advice services and charities that can help you create a plan and talk through your finances. Get in touch with the team at StepChange or National DebtLine to get help.
How To Pay Off Your Overdraft: Key Takeaways
- An overdraft is an extension of credit attached to your bank account which allows you to spend more than the balance in your account. A limit with be set and agreed by your bank.
- In 2017 it was highlighted that overdraft charges and unarranged overdrafts were the biggest revenue streams for traditional high-street banks.
- Although overdrafts are often perceived as a benefit to a bank account, they are still a form of debt. Using an overdraft or going over your overdraft can result in interest, charges and additional fees.
- You can consolidate multiple loans and credit cards with a peer-to-peer loan into one monthly repayment.
We want to know your thoughts - how often do you dip into your overdraft?
Is it how you get through the month or is it something you never use but like to have there?
Let us know in the comments!