Bank Accounts with an Overdraft

Put simply, an overdraft is a form of borrowing money, as it allows us to spend more than we have in our bank account. They're meant to be used as a safety net for the odd expensive month or unexpected bill, rather than as an extra source of money.

There are two forms of overdraft borrowing: planned and unplanned, also known as authorised and unauthorised, or formal and informal overdrafts. The key difference is that we request the use of a planned overdraft in advance, whereas an unplanned overdraft comes as a surprise to our bank.

An authorised overdraft will always be cheaper, because even if we don't use it, it shows that we've planned ahead. By contrast, going into unauthorised overdraft suggests that we're not managing our money very well, particularly if it happens fairly often.

Many banks and building societies offer new customers the chance to apply for an overdraft when they're opening a new account, in which case it's simply a matter of stating that we'd like to be considered and stating how much we'd like to be able to borrow.

There's no guarantee that a request will be successful, however, as it depends on the result of the credit check. The bank will look in particular at whether we have, or have had, any other planned or unplanned overdrafts, other lines of open credit, and how we're dealing with any debts we have. Depending on their assessment, we may be granted the full overdraft we've asked for, turned down, or offered an overdraft with a lower limit.

Most current accounts now come with a "buffer" facility, which allows us to go a little overdrawn without facing penalty charges or having a scheduled payment fail. This is not the same as having an authorised overdraft, which must be applied for and approved by the bank.

In general, only students and graduates will be able to find a good range of accounts offering truly free overdrafts. The limits are generous, but there are still penalties for going over them - and once a student has graduated they may find they're expected to pay back their overdrafts in as little as a year, although up to three is more common.

For the rest of us, there are several current accounts that aim to attract new customers with the offer of a fee-free overdraft for an introductory period, ranging from a few months to a year. There are also a few current accounts that offer genuinely free overdraft facilities, but only for fairly low amounts; these accounts are considered premium, so expect them to come with a monthly fee or to require a significant minimum monthly deposit.

There shouldn't be any charge to apply for an overdraft, or for having an agreed overdraft in place but not using it. If we need to use the facility, however, it will almost always cost us. Some banks charge interest on the amount we borrow, calculated daily and collected monthly; others charge a daily fee. Some banks also charge an access fee for any month when we need to use the overdraft.

Be careful with current accounts that claim to offer "interest free" overdrafts, as they're likely to levy daily and/or monthly fees for them instead. The appeal of a flat fee is that the cost of borrowing is much simpler to calculate than when percentage rates are involved.

While they are much simpler to work with, however, flat fees can be much more expensive depending on how much or how often we need to borrow, particularly if there's a monthly access fee involved. Also check if the account in question offers a monthly cap on overdraft charges, but be aware that this can still result in high monthly costs.

As different banks charge different rates and fees for their overdrafts, moving to an account that offers one more suited to our needs can save us a lot of money. As long as we've stayed within our agreed overdraft limits and have a reasonably good credit history, we should be able to move to another bank with a better overdraft.

It's worth double checking what we're already paying in rates and fees, and getting proof of the overdraft limit - this can usually be found on an account statement. Then when we've found an account that suits us better, use the current account switching service to move, as most banks will ask how big an overdraft we have or need - and often they'll offer to match whatever we already have.