How to pay off your overdraft

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If you are overdrawn every month or have been stuck in the red for a while, there are ways to pay off your overdraft for good.
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An overdraft can give you a bit of much-needed wiggle room when it comes to managing your finances. But is it always the best option for borrowing money? Read on to discover everything you need to know about overdrafts and overdraft charges.

Do you need an overdraft? 

An overdraft is designed for short-term borrowing or emergencies. 

You can usually borrow up to an agreed overdraft limit, and you’ll usually need to pay your bank interest for the privilege.

An overdraft isn’t usually the best solution for longer-term or frequent borrowing as interest charges can be high. Managing your overdraft debt more smartly can ensure that the costs don’t spiral.

What is an overdraft? 

An overdraft is a way of borrowing money from your bank or building society. With an overdraft, you can spend or withdraw more money than you have in your bank account. 

Your overdraft will need to be repaid at some point, and you’ll usually pay interest on top as it’s a kind of loan. There could be cheaper ways to borrow because high overdraft charges mean that it’s not always the best option.

How does an overdraft work, and what overdraft charges can I expect?

Overdrafts charge interest. So it’s important to be aware of how much your overdraft is costing you. 

In April 2020, overdraft fees were overhauled. As a result, interest is now charged on your overdraft at a single annual interest rate (APR). This rate could range from 19% to 40%, depending on the bank or building society. So it’s important to compare overdraft charges when you’re choosing an account.

These changes also mean that banks are no longer allowed to charge:

  • Higher interest rates for unauthorised overdrafts

  • Daily or monthly fees for the use of your overdraft

Are there different types of overdrafts?

Yes, there are two types of overdraft.

An arranged overdraft or authorised overdraft is one that you’ve agreed with your bank in advance of using it. Your bank sets an overdraft limit, and you can spend or withdraw money up to that limit. 

An unarranged overdraft or unauthorised overdraft is one that hasn’t been planned. You’ll have one of these if you’ve spent more money than you have in your bank account without agreeing to it with your bank first. You may also have one of these if you’ve gone over the limit of your arranged overdraft.

How do you apply for an overdraft?

It’s usually very easy to apply for an overdraft, as long as you’re eligible. You’re usually more likely to be accepted or be offered a larger overdraft if you have a good credit score.

If you want an overdraft facility to be added to a bank account you already have, you may be able to:

  • Talk to the bank

  • Head to the website to apply

  • Use the mobile banking app

Alternatively, if you’ve found a new bank account with an overdraft facility that appeals to you, you can apply to open or switch to that bank account and request an overdraft as part of that process. Some bank accounts even offer a bonus for switching to their product, and this could help towards paying off your overdraft.

Staying on top of your overdraft

If you do have an overdraft, here are some of the best ways to make sure it doesn’t spiral:

  • Keep a close eye on your bank balance using mobile banking

  • Sign up for text alerts when you go into your overdraft or when your balance gets low

  • Read all letters from your bank

  • Spend sensibly

How do you pay off an overdraft?

Having an overdraft can be helpful when it comes to managing your funds. But, if you’ve been stuck in the red for a long time, or if you’re using your overdraft every single month, it might be sensible to look into how you could pay it off.

Before you take the next step, you should find out the current balance of your overdraft and how much you are being charged in interest.

If you aren’t sure, contact your bank or check your most recent statement. Knowing how much you owe on your overdraft and what interest charges you pay each month will help you formulate a plan.

Your overdraft charges might mean that you’re not borrowing in the most cost-effective way. Here are some steps you can try:

Move your overdraft debt to a 0% money transfer credit card 

You can use a 0% money transfer credit card to clear your overdraft – these work by allowing you to transfer money from your credit card into your bank account. You can then use the amount borrowed to clear your overdraft and pay back your credit card provider during the interest-free period. This could be several months, giving you plenty of time to clear your debt without being charged interest. 

Before switching, you need to be aware of:

  • Handling fees: Most 0% money transfer credit cards apply a fee of around 4% of the amount borrowed. This could amount to less than paying overdraft charges, but it’s important to work it out to be sure.

  • Interest-free period ending: When your deal ends, you’ll be charged the lender's standard rate unless you’ve paid off the balance. You should aim to pay it off before that time.

Compare 0% money transfer credit cards.

Check which credit cards could accept you.

Move to an interest-free overdraft

You might be able to move your overdraft balance to a current account with an interest-free overdraft.

This means you’ll stop paying any overdraft charges on your account, and it will give you time to pay off the balance of your new overdraft.

Switching bank accounts is quick and easy, but you’ll need to find a new account that offers you a big enough interest-free overdraft. Some interest-free overdrafts only last a set amount of time, so it’s important to check. 

How to switch to a new overdraft.

Consider a low-rate personal loan instead of an overdraft

If you’re paying extortionate overdraft charges, you could take out a personal loan to pay off your overdraft. A low-interest rate could save you money in the long run.

Choosing the right loan can reduce your interest payments, which means you can pay off your balance faster and pay less interest.

Compare unsecured loans.

Budget to pay off your overdraft

If you can be disciplined and are determined to pay off your overdraft, try setting yourself a strict budget to pay off your debt gradually, month by month.

To help, it’s worth looking at exactly what goes out of your account and what comes in every month. Work out where you can make savings so that some of your income goes towards the debt. By budgeting strictly, you’ll eventually eliminate your debt.

How to write a budget

You can even ask your bank to reduce your overdraft limit each month in line with the amount you’re paying. By doing this, you’ll remove the temptation to stray into your overdraft again.

Use your savings to pay off your overdraft

If you’ve got savings, you could use these to get yourself out of your overdraft.

Savings rates offer far lower interest rates than most overdrafts. So your money would be better spent paying off debt and reducing the interest on your overdraft. 

Should I use my savings to pay off my overdraft debts?

Close your overdraft 

Paying off your overdraft will be well worth it when you’re no longer in the red and can close your overdraft facility for good.

If you feel tempted to dip into your overdraft when you’ve paid it off, remember how much you were paying in interest, how long it took you to pay it off and the stress it caused you.

Closing the overdraft facility can be a good way to remove this temptation.

What to do if your bank puts up your overdraft rate

What happens if I can’t pay my overdraft?

If you’re still struggling to pay off your overdraft, the best thing to do is to get some support. 

It’s not always easy sharing your financial problems with others, but try to talk about your plans with family and friends who could help you. If you prefer to seek professional assistance, you could speak to one of these charities for free advice:

They could help you with finding your way out of debt.

Dealing with debt - where to start

New bank accounts are offered all the time, so compare all of the best options to make sure you get the right one for you.

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