Overdrafts
Oh no, gone overdrawn again? Here's how to understand overdrafts and keep on the right side of your bank manager.
The basics
An overdraft is an agreed cash-borrowing limit that is arranged with your bank. It gives you a flexible way of managing your cash flow and can provide you with short term funds if you don't have enough money. An overdraft is not a loan.
An example of when an overdraft can help you: you have an urgent phone bill to pay today but you don't have funds going into your account until next week. The overdraft enables you to pay off the bill, without having the appropriate amount of money in your account.
As with all forms of credit, you must be over 18 years of age before you can apply for an overdraft.
How do I arrange one?
You should talk to someone at your local branch. Some banks or building societies can arrange an overdraft through their telephone or internet banking service.
Try and avoid going overdrawn if you haven't arranged it with your bank. You'll be charged a much higher rate of interest for unarranged borrowing, and may also be charged for any letters sent by the bank. Call the bank if you think you're about to go unexpectedly overdrawn, they're more likely to be sympathetic if you warn them.
What are the benefits of an overdraft?
Overdrafts are ideal for borrowing money that you know will be replaced quickly when your salary or regular funds are paid into your account. However, it doesn't work out as good value if you are borrowing thousands of pounds in this way and never clearing your debts.
What are the disadvantages
- Some banks charge a fee for setting up an overdraft
- Overdraft facilities can be withdrawn by banks or building societies at any time
- If you go overdrawn before agreeing a limit with your bank you will have to pay additional charges
- If you go overdrawn above the limit agreed with your bank you will also face higher charges
- If you are overdrawn and decide to transfer your bank account you must pay off your overdraft first because you are in effect in debt to the bank.
Free or cheap overdrafts
It's worth checking if your bank has a buffer zone that allows you to go slightly overdrawn each month without incurring the high charges usually associated with unauthorised overdrafts. There may be a small annual charge for this facility. Some banks and building societies also offer preferential terms to students, which could mean that overdrafts attract reduced interest rates, or are free up to a certain amount.
Unfair charges?
If you go over your agreed overdraft limit, you may be charged a 'default charge', which can be anything from £20 to £40 for a single charge. Surprisingly, your bank should actually only charge you what it costs to cover their admin charges, however they often charge much more than this.
There have been so many complaints about unfair overdraft charges that the Office of Fair Trading (OFT) took a test case through the courts. The courts decided the OFT could decide if bank charges were too high, but the banks are appealing. Until this appeal is heard, the OFT will not be able to rule if charges are unfair.
However, if you are in hardship and you have outstanding overdraft charges, you can claim against your bank. See MoneySavingExpert's guide to Bank Charges for people in Hardship.
The law is different in Scotland, and as a result some Sheriff courts are allowing cases to be heard.
Thanks to the Citizens Advice Bureau for help with is article.
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