Overdrafts are simple to operate, convenient to use, and helpful for those times when cashflow is tight or you need to make a big purchase at short notice.
However, they can also be expensive, especially if you borrow without arranging (authorising) the overdraft first, or forget to check the charges your bank or building society imposes for being overdrawn.
Monthly fees mean that even being in the red for a small amount and for a short period of time, may cost more than you expect. Being just £15 in the red for a day might rack up high charges.
There is a huge variation between products and providers, and charging structures have become more complicated, making it more difficult to shop around and compare prices. Now as well as a daily interest charge, there may be fixed monthly fees, even for arranged/authorised overdrafts.
Gillian Guy, CEO at Citizens Advice, recently highlighted what she called the “problem of the £1.2 billion overdraft charges” that current account consumers are paying.
Speaking at UK Finance’s conference in London, she said consumers were still overpaying for current accounts. With the advent of open banking, financial services companies needed “to be trustworthy, not overpromise and underdeliver, lead from the front and avoid a race to the bottom,” she said.
Andrew Hagger of Moneycomms said that some banks are charging their credit worthy customers the kind of rates they might normally reserve for those with a poor credit history.
“There is a huge and unfair variation in charges between providers,” he says. “At one time all you would pay to use an overdraft was a daily interest charge, typically around 15% to 20% EAR – making it simple to compare.”
Banks say daily fees are easier to understand – that may be the case, but for many people it can also prove to be far more expensive than a standard interest rate tariff without a fee.
“Some banks, like First Direct, charge a simple daily interest, which is the way it used to be,” Mr Hagger says. “Some of the very high rates that other banks are charging look difficult to justify.”
Many overdrafts carry fixed monthly or daily fees, and so even dipping into the red for 48 hours might be expensive. Some banks, like TSB, NatWest and RBS, charge a £6 monthly fee for the month in which you borrow on an authorised overdraft.
With NatWest, if your overdraft is unauthorised, you’ll pay £8 per day, up to a maximum charge of £80 per month. It’s easy to see how small amounts of borrowing can quickly mount up to big fees.
If you find that you often need to use your overdraft then it may be worth finding a bank account with lower overdraft charges.
Borrow £500 for seven days with First Direct and it will cost you 71p – but with NatWest/RBS and TSB it’s more than ten times that amount (see table below). When all the charges are taken into account, the total interest rate is 81%.
If you are looking for an alternative to the high street banks, then Metro Bank, M&S Bank and the Post Office all have better deals than NatWest, Santander, Halifax, Barclays and Lloyds.
Lloyds Bank, Bank of Scotland and Halifax charge 1p per day for each £7 borrowed. While that might not sound like much, it is equivalent to an interest rate of around 52% – way above the 35% to 40% that a credit card company might charge on a bad credit credit card.
One option you might consider, if you know it is going to take a while to pay off the debt, is to move your outstanding debt onto a card.
The longest duration balance transfer and money transfer cards will get you 0% interest on transferred debts for around 36 months. Before you switch, though, check whether there is a transfer fee and whether you will save money once you have factored that in. It might make sense to get a card with a shorter 0% period but with lower (or no) fees. As with all forms of credit, make sure you have a plan for paying off the card before the 0% interest period ends.
It’s common to dip into the red if a regular direct debit is taken from your account before a cheque or cash transfer is cleared. To avoid this, you can anticipate when you might step into overdraft territory by using an app to predict your cash flow and bank balance.
For example, Money Dashboard shows exactly where your money goes across all your online financial accounts. On most accounts, transactions and balances are refreshed daily, so you’re up to date with your current financial position at a glance. This information is then displayed in your personal dashboard. Banks that are on the dashboard include Bank of Scotland, Barclaycard, Barclays, First Direct, Halifax, HSBC, Lloyds, MBNA, Nationwide, NatWest, RBS and Santander.
It’s hard to compare fees, but the table below shows that some banks offer a far more reasonable level of charging by using a simple daily interest rate which works out at a fraction of the cost to the borrower.
“It’s early days for Open Banking but in time it should help people to compare products and services,” says Andrew Hagger. “It is difficult to work out the best deals at the moment and the banks know that is why people stick with the same account, even when charges are relatively high.”
The Financial Conduct Authority (FCA), the consumer watchdog, has conducted an 18-month review into high-cost credit. In May this year it stepped back from a cap on overdraft fees but ordered banks to do more to help borrowers and warn them about going into the red.
|Bank||Account||Tariff for agreed overdrafts||Cost £500 x 7 days||Equivalent interest rate|
|NatWest/RBS||Select||£6/month + 19.89% EAR||£7.75||81%|
|TSB||Classic||£6/month + 19.89% EAR £7.75 81% TSB Classic £6/month + 19.85% EAR (First £25 free)||£7.67||80%|
|Santander||123||£1 per day up to £2,000||£7.00||73%|
|Barclays||Bank Account||75p per day up to £1,000||£5.25||55%|
|Lloyds Bank||Classic||1p per £7 borrowed per day||£4.97||52%|
|Halifax||Reward||1p per £7 borrowed per day||£4.97||52%|
|Metro Bank||Current||15% EAR||£1.34||15%|
|Starling Bank||Current||15% EAR||£1.34||15%|
|Post Office||Standard Account||14.6% EAR||£1.32||14.6%|
|M&S Bank||Current||15.9% (First £100 free)||£1.14||15.9%|
|First Direct||1st account||15.9% (First £250 free)||£0.71||15.9%|
Data via Moneycomms.co.uk. Last updated June 20, 2018.