With many banks introducing a raft of extra charges for use of your overdraft facility, finding out the 'real' cost of your overdraft is essential. We show you how.
While you can't beat it for convenience, dipping into your overdraft even for just a few days could mean you’ll be hit with hefty fees that bump up the cost of your borrowing significantly.
Here’s how to work out how much your overdraft is costing you:
Working out the real cost
The vast majority of overdraft facilities charge some form of interest or apply a fee when you use them.
Even those that offer fee-free or interest-free borrowing up to a certain limit will levy harsh interest charges if you exceed this.
Knowing exactly what rate of interest you’ll pay means you can make an informed decision about whether your overdraft is worth using, or if there is a cheaper way to borrow money.
Lenders must state all of the interest rates and fees for your overdraft clearly in your account’s agreement and/or terms and conditions, and this should be the first place you should check. You can get this information from your bank’s website or by contacting your nearest branch if you don't have a copy at home.
Look through you paperwork and find out:
1. Your overdraft limit:
This is the maximum amount you are allowed to withdraw any funds in your current account.
It's important to know what your overdraft limit is so that you can stick within its confines and be confident about how much you can borrow without further penalty.
Anything below your limit is class as ‘authorised’ borrowing. While any spending beyond your limit is deemed as being ‘unauthorised’ and so will incur additional fees and charges.
2. Any interest free limit:
Some current accounts offer a portion of their overdraft facility, usually between £50-£250, interest free.
When you are calculating the cost of your overdraft make sure you find out if you have an interest free overdraft & if so what the free limit is. You'll then be able to factor this into your cost calculations.
3. The interest rate for authorised borrowing:
After factoring in any interest free limit you will need to find out the rate of interest applied to your approved overdraft facility. This should be clearly stated in your account terms and conditions.
This piece of information is especially useful for comparing the cost of overdrafts offered by other accounts and working out exactly what yours is costing you.
4. The interest rate for unauthorised borrowing:
The rate of interest applied to unauthorised borrowing will be significantly greater than that charged on borrowing within your approved limit. So if you occasionally exceed your limit you will pay for the privilege and should add in this extra cost to your calculations.
5. Authorised overdraft fees:
An increasing number of lenders now apply a fee when you use your overdraft facility. Often this is marketed as making the amount you pay clear and simple, however these ‘usage’ fees are often on top of the interest you’re charged.
As these fees can increase the cost of your borrowing significantly you will need to find out whether you are being charged a fee for your overdraft, and if so how much it is and how often it's applied. Some accounts will apply a charge for every day you're overdrawn, while others will apply a single fixed fee once during the course of any month you use your overdraft facility.
6. Unauthorised overdraft fees:
If you borrow beyond your overdraft limit then you will soon start racking up hefty fees on top of any interest you are already charged.
It is these charges that have been the subject of complaints to the Financial Ombudsman in recent years. As a result some of the banks have reduced their fees due to public pressure. However the amount you can be charged can still be quite substantial so you need to find out what you'll be paying.
7. Annual fee:
Some accounts charge an annual overdraft fee on top of the interest you pay on your borrowing. This may be in the form of a packaged account subscription or simply an annual admin fee for having an overdraft facility. It’s easy to forget one off annual charges but the still contribute towards the cost of having an overdraft so you need to check whether you've been paying any.
Calculating the cost
Now you know all the different elements that contribute towards the cost of your overdraft you can start to work out exactly how much you are paying.
The best way to do this is to first assess how often you use your overdraft. You can do this by looking at your previous bank statements to see just how often you go overdrawn and by how much – if you take an average from the last 3 months you will get a good idea of your banking habits.
Work out how much you spend on monthly & daily overdraft charges each month together with what you pay in authorised & unauthorised interest.
Once you’ve added up all the interest, fees and charges you incur during the course of each month you will have an idea of the true cost of your overdraft.
Unless this is near zero it’s likely that there are cheaper ways for you to borrow the money.
What are your other options?
If you find that your overdraft is costing you more than you expected then there are a number of other options that are well worth looking at.
1. Budget and stay informed
The best way to avoid overdraft charges and fees is to budget your spending so you know exactly how much cash you have to play with. Draw up a budget for each month and monitor how much you have coming in and going out so you avoid dipping into your overdraft completely.
Try following our Action Plan How to stick to a budget or read our guide How to Write a Budget for tips on how to get started.
All the major banks offer online and mobile banking services which make checking your account easier and quicker than ever before. You can also set up alerts to text or email you if you are about to go overdrawn to help avoid unnecessary charges.These can be really handy tools for keeping on top of your bank balance.
If you think that the temptation to use the overdraft will just be too great then you can always ask your bank to remove the facility once you’ve cleared your debt. However if you do this the bank are under no obligation to re-instate it if you need it again at a later date.
2. Use your savings
If you find that you spend most of the month overdrawn then you will need to try cancel out the debt or move it to a cheaper home, one way is to use any savings you have available to wipe out your overdraft.
In most cases the amount of interest you’ll earn from a savings account will be far less than what you pay for using an overdraft – after all that is how banks make their money!
So if you have savings available and you won’t be penalised for taking them out you should look at using them to clear your overdraft.
3. Use a credit card to clear your overdraft
Moving your overdraft debt onto a credit card is another option which may save you money in the long term. You can do this by requesting a money transfer from your credit card to your current account.
However, before you look at this option you will need to factor in any money transfer fees and credit card interest to make sure you will pay less overall. You'll also need to draw up a repayment plan so that you work towards clearing the debt and budget your spending so you don't fall back into your overdraft and end up in a worse situation than before.
4. Look at moving to a cheaper current account.
For many people this can be a daunting prospect; however you might be surprised just how easy it is to switch and it could mean big savings on interest and fees.
Your priority should be to find an account that offers a cheaper overdraft facility but there are also lots of extra incentives on offer for people willing to switch that might make it worthwhile.
For extra guidance read How to Choose an Overdraft Current Account.
Can you ever really have a free overdraft?
There are a couple of notable exceptions when it comes to interest charges on overdrafts, the main one being student and graduate accounts which often offer interest free overdraft facilities.
However, even if you’ve been given an interest free overdraft you will still need to be aware of your limit or you could still incur fees and charges.
The interest free element of any student or graduate account will not extend to unarranged borrowing and chances are you will pay
You should also remember not to treat your interest free overdraft as a target to aim for – once you graduate you’ll soon start to pay interest on what you’ve borrowed.
