How to get a cheaper overdraft

justin schamotta
By Justin Schamotta

woman wallet©iStock.com/flyfloor

OVERDRAFTS are meant to provide a safety net for short term cash flow problems.

They allow account holders to borrow money up to a specified limit and can be useful for making sure regular payments are met.

Commonly, however, the fees and interest that banks charge people for using this safety net means that customers often end up paying so much that it starts to become a problem.

For anyone who thinks this sounds familiar we've created a three-step plan to help people get a cheaper deal - covering 0% overdrafts, authorised overdrafts and other ways to help reduce the financial burden of this form of borrowing.

1. Get a 0% overdraft

Overdrafts are essentially a loan from the bank - they're just attached to our current accounts.

The account holder is usually charged a daily fee for entering the overdraft (with a maximum monthly charge that varies from bank to bank) and some interest on the value of the loan.

So if we treat overdraft loans in a similar fashion to credit card loans, a tactic to pay less is with a 0% overdraft arrangement. This is like a 0% credit card - with a defined interest free period in which to borrow.

Having an overdraft with no interest sounds great, but in reality these deals are increasingly limited by the banks and tend to offer only a few hundred pounds interest free.

Additionally, some accounts require holders to pay large sums of money into the account every month, or only offer a decent fee-free overdraft as part of an account with a monthly fee.

Limited 0% overdrafts

Interest free overdrafts typically last up to a year before they revert to a normal rate of interest or fee structure.

Let's illustrate this point with three examples:

Bank and account Overdraft Account requirements
Nationwide
FlexDirect (more details)
0% for 12 months £1000/month
deposit
First Direct
1st Account (more details)
0% on £250 £1,000/month
deposit or a £10 month fee
Santander
Everyday Current Account (more details)
0% for four months Switch using dedicated
switcher service

There's more information in our current account table here.

As the table above shows, all of these 0% overdrafts come with conditions that must be met, from monthly deposits and fees to only being available to new account switchers.

The overdraft incentives are also quite weak, aside from the Nationwide account which offers a full year at 0%.

It's also really important to note at this point that all of these overdraft deals are for arranged or authorised overdrafts.

As opposed to an unarranged or unauthorised overdraft, which is when an account holder spends more than they have without prior arrangement with the bank, arranged overdrafts are agreed with the bank in advance. The account holder can spend within the agreed limits for the agreed fees and interest rates.

Also, note that these accounts are examples only. The details were correct at the time of updating, but can and do change.

Student/graduate accounts

The other 0% option is limited to current and former full-time students.

Banks are typically keen to get students and graduates banking with them. They usually offer some form of 0% overdraft on their student accounts, typically up to £3,000.

Most banks offer tiered schemes in which the overdraft limit is increased every year but still remains interest free.

Even after graduation, the 0% period doesn't necessarily have to end.

Some banks offer graduate accounts that allow ex-students to enjoy an interest free overdraft for up to three years.

The aim with these accounts is to allow graduates to reduce their overdraft over time without onerous charges, because by the time the interest kicks in they should have been working for a few years and ideally have already paid the overdraft off.

2. Get the best authorised overdraft

As we mentioned earlier, authorised overdrafts are planned in advance with the bank and allow account holders to enter an overdraft facility and spend up to a pre-agreed limit. There are usually fees and interest applied to the loan by the bank.

For anyone looking for the best authorised overdrafts there are a few things to look out for.

Interest or daily fees?

For a typical arranged overdraft, customers may find themselves subject to a fee for using the facility - although many accounts are now increasingly fee-free - then they are charged an annual rate of interest (usually between 15% and 20% a year) on the value of the loan.

For example, the TSB Classic Account provides arranged overdrafts with a £6 per month overdraft usage fee and a 19.84% EAR on the value of the loan.

  • Internet, Mobile and Telephone Banking
  • £25 interest and fee-free planned overdraft (subject to application and approval)
  • Save the Change - an option to round up transactions and store the difference in an eligible TSB savings account

An alternative is for account holders to face a simpler daily charge for the period they're overdrawn, usually - but not always - subject to a monthly cap.

For example, the Halifax Reward current account has the following daily fee structure for its planned overdrafts:

  • £3 reward each month: pay in £750, have at least two direct debits and stay in credit
  • £125 cashback when you switch to Halifax
  • £50 overdraft buffer (subject to status)

Banks that charge daily fees rather than annual interest rates usually advertise their overdraft as being interest free.

Nevertheless, it's important to remember that these daily charges can result in customers paying out a lot more than they would with a fixed rate of interest.

Buffer zones

A sizeable number of banks now provide their customers with a buffer zone, allowing them to go overdrawn by small amounts without incurring any penalty fees or interest.

In November 2011, Barclays, Lloyds Banking Group and HSBC agreed to provide their customers with a buffer zone of between £5 and £10, but now many banks offer a more generous buffer.

For example, the TSB Classic Account and the Halifax Reward Account mentioned above both offer overdraft buffers before fees kick in - with TSB offering £25 and Halifax offering £50.

Back in 2011 the banks also agreed to alert customers if their account became close to being overdrawn.

These measures have proven popular and effective. The Financial Conduct Authority (FCA) says that people who receive such warning texts tend to incur lower charges, particularly for unarranged overdrafts, than those who don't sign up to receive such messages.

Unauthorised overdrafts

Banks aren't obliged to provide overdrafts. It's up to them whether they agree to provide an authorised overdraft facility based on their assessment of an account holder's credit worthiness.

If there is no pre-arranged overdraft facility and an account becomes overdrawn, that's an unauthorised overdraft.

Similarly, if a customer exceeds the agreed limit of an authorised overdraft, they've entered into an unauthorised overdraft.

Banks will typically refuse to honour cheques or efforts to withdraw money from an account that is close to entering an unauthorised overdraft and may levy a charge when such payments are attempted.

If the bank does allow an unauthorised overdraft, it will typically charge fees and interest on the overdrawn amount.

An investigation by the BBC in 2011 found that a Santander customer borrowing £100 for 28 days without the bank's consent would have to pay back £200.

It seemed that consumers were on the whole unaware of the incredibly high cost of going overdrawn without authorisation.

Also back in 2011, the EU's Consumer Credit Directive, which we looked at here in relation to a similar problem with credit cards, tried to get financial institutions to advertise their fees and conditions more clearly for consumers to understand - in order to avoid similar situations to the one uncovered by the BBC.

But following years of similar stories, in 2016 the Competition and Markets Authority (CMA) insisted that banks impose monthly maximum caps for unarranged overdraft fees.

However, the banks are free to set both these monthly maximums and any daily fees that account holders must pay for an unplanned overdraft.

For example, the TSB Classic Account charges the following daily fees for an unauthorised overdraft:

The maximum monthly payment for this account is £80.

Therefore, someone who is habitually within this unplanned overdraft never pays more than £80 per month, but someone who enters it for a few days is hit relatively hard.

Interestingly, as part of the Lloyds banking group - along with Lloyds and Bank of Scotland, from November of this year Halifax will remove all fees and charges for its unplanned overdrafts following a recent decision to do so by the banking group.

We'll have to wait and see if other banking groups follow this example and make unplanned overdraft fees a thing of the past.

But remember that as a general rule it's usually the preferable and safest thing for customers to arrange some kind of overdraft facility in advance.

3. Reduce overdraft costs another way

The most obvious way to reduce the cost of an overdraft is to treat it just like any other debt and budget until it's paid off in full.

It's often hard to budget and put more money towards repaying debts, but it can be done. For example, there are a number of sites that can track spending, basically making individual budgets for their users.

Cut costs: read more
Make a budget: more
Dealing with debt: more
Backwards budgeting: more

We've got lots more information on budgeting in our guides - read more by clicking on the links to the right.

Aside from budgeting to pay off an overdraft, there are a couple of other options that people can try.

Using a money transfer

Like a 0% balance transfer deal, a money transfer offers an introductory 0% interest deal in which to move credit around.

Unlike balance transfers, in which money is moved between credit cards, with money transfers the credit card balance can be moved to a current account.

This is handy when there's an overdraft to pay for because the balance from the money transfer card can be put directly in an account and used to pay off its overdraft.

However, the fee for transferring can be high - often higher than for making a balance transfer - and missing just one minimum repayment can invalidate the 0% terms, landing the borrower with another debt on which to pay interest.

Find out more in this guide.

Reclaiming charges

Finally, for people who feel they have been charged unfair or excessive overdraft fees, they can try to reclaim the charges from their financial provider.

Those who can show they're in financial difficulty have the best chance of reclaiming charges, such as people who can't cover the cost of basic necessities or debts, or who have recently suffered from a substantial drop in income.

However, as our reclaiming guide proves (available here), just about anyone has a chance to get charges back if they have a reason and they at least try.

Customers can phone or write to their bank to ask for charges to be refunded and, if necessary, go through the bank's official complaints procedure. There's nothing to lose - except perhaps a little bit of time spent writing an email or making a phone call.

If this fails, complainants can seek free help from the Financial Ombudsman Service.

Also, remember to avoid claims management companies as they'll just charge for claiming refunds on someone's behalf. It's fairly easy for anyone to complain and much better to keep all of the refunded charges, if successful.


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