Overdrafts explained

An overdraft can be a great safety net for emergencies or necessities. Thinking about getting one? Check out our guide on what you need to know.

Written by

The Editorial Team

Experts in personal finance, insurance and utilities

Last Updated

25 NOVEMBER 2021

8 min read

How does an overdraft work?

An overdraft allows you to borrow money through your current account. You have to apply for an overdraft and it has to be approved by the bank. Your bank will agree on an overdraft limit, depending on your income and outgoings, as well as your credit score. This agreed limit is your arranged (or authorised) overdraft.

There’s usually no cost involved in putting the overdraft in place. If you don’t use it, then you won’t be charged for having it.

How is an overdraft useful?

Overdrafts can be useful if you’re temporarily short of money. For example, you get a puncture and need to replace a tyre – you haven’t budgeted for this, so you use your overdraft to tide you over until payday.

What are the different types of overdraft?

Arranged overdraft

This is agreed by your bank. You’re entitled to go into your arranged overdraft up to the agreed amount. For example, if your arranged overdraft limit is £1,000 and you have £200 in your account but spend £450, you’d be £250 into your overdraft. This would leave you with £750 of arranged overdraft available.

Several banks offer you some wiggle room on your account for free. These interest-free overdraft buffers can vary from £15 to a couple of hundred pounds and will usually be set when you open your account, but may change as your circumstances change.

Unarranged overdraft

If you go over your arranged overdraft, or you go overdrawn without having an arranged overdraft, then you’ll be in unarranged (or unauthorised) overdraft territory.

Higher interest rates used to be charged for unarranged overdrafts, but since April 2020 this is no longer the case. Arranged and unarranged overdrafts are now charged at a single rate of interest, and there are no monthly or daily fees for being overdrawn.

An unarranged overdraft could also affect your credit score, making it more difficult to get a loan in the future.

Do you need an overdraft?

Because of the cost of overdrafts, it’s probably worth using yours only for short-term funding and emergencies. If you’re likely to be overdrawn for any length of time, it might be worth looking at another type of credit - for example, 0% credit cards.

What are the recent changes to overdrafts?

In April 2020, the Financial Conduct Authority (FCA) introduced major changes affecting how banks can charge for overdrafts. Under the new rules:

banks can only charge a simple effective annual rate (EAR) of interest, without additional fees and charges
the same interest rate is charged for arranged and unarranged overdrafts
there's a ban on monthly or daily fees for being overdrawn
banks must publish the annual percentage rate (APR) on their overdrafts, making it easier for customers to compare charges between accounts

If you’re concerned about the changes and how they’ll affect your overdraft, talk to your bank. They can evaluate your overdraft and, if you’ll be worse off, may be able to offer a cheaper way of clearing your outstanding balance. The FCA states that under the new rules, banks must be willing to support and offer practical help to customers who are worse off and vulnerable because of the changes.

With the end of the interest holiday, banks and building societies have been returning to their business-as-usual interest rates for overdrafts, which could be up to 40%. This means that costs on your overdraft could rapidly increase.

Some banks are still capping the maximum you can be charged on your overdraft and offering interest-free overdrafts, although they are no longer required to. Check with your bank to work out what your situation is, and if and when the overdraft rate will change if it hasn’t already.
Instead of a blanket £500 overdraft, your bank is now expected to offer personal, tailored help.

This could include:

Reducing or waiving interest
Transferring your overdraft debt to an alternative loan with more favourable terms
Agreeing a repayment plan
Offering advice on money management

If you need help getting to grips with your overdraft and getting yourself back in the black, talk to your bank or building society to see if they can offer any of these options to help you.

Please note: This information was correct at the time of publication on 22 NOVEMBER 2021 but, because of the impact of COVID-19, things can change rapidly. We aim to keep this page updated, but please check with your bank directly to confirm any details.

What our expert says...

“There's no doubt that current account providers offered many households a lifeline by providing interest-free overdrafts during the pandemic. However, overdraft interest rates have slowly been creeping back up.

“Many households will still be under financial strain and in need of funds to help tide them over. If you’re still struggling, contact your bank for tailored support."

- The Editorial Team, Experts in personal finance, insurance and utilities

How do overdraft fees and charges work?

Now that the FCA has done away with monthly and daily charges, both arranged and unarranged overdraft fees are included in a ‘flat rate’.

Most banks and building societies now have an overdraft calculator for customers to use on their websites. These calculators let you work out how much it would cost you, once you either have to start paying interest on your overdraft again, or if you were to start using an overdraft in the first place.

An overdraft calculator can show you what it would cost to have an overdraft of, for example, £500, for different lengths of time, from one day up to three months:

Length of time overdrawn	Amount of interest to pay on a £500 overdraft at 39.9% equivalent annual rate (EAR)
1 day	46p
7 days	£3.22
14 days	£6.44
31 days	£14.33
60 days	£28.09
90 days	£42.69

Some bank accounts give you an interest-free buffer, so as long as you don’t go overdrawn by more than that buffer amount, you won’t have to pay anything.

What is EAR?

The EAR is essentially a representative interest rate that shows the rate you’d pay if you remained overdrawn on your current account for a year. It doesn’t include any other fees that the bank can charge.

Does using an overdraft affect my credit rating?

An overdraft will show up on your credit report as a debt so, yes, it will have an impact on your credit rating.

But if you stay within the limit and make regular payments, an arranged overdraft could help improve your credit score. Regularly clearing your overdraft shows lenders that you’re a reliable borrower.

An unarranged overdraft, however, could be a red flag. It shows lenders that you might be struggling with your finances and this could have a negative impact on your credit score. Going over your limit and constantly dipping into your overdraft could also damage your credit rating.

Top tips for managing your overdraft

It’s vital that you stay in control of your finances when managing an overdraft. Here are our top tips for staying in the black.

Regularly track your account via the bank’s app, online or phone banking.
Read all letters from your bank immediately – they may contain important information about your overdraft.
If you have any savings, it may end up cheaper using them to pay off your overdraft.
Give yourself a monthly spending budget and stick to it – any money you manage to save can go towards paying off your overdraft.

How do you pay off an overdraft?

Here are some tips on paying off your overdraft:

Budgeting – if you need to pay off your overdraft in installments, you’ll need to budget for it. There are loads of apps out there which can help track your spending and help you save, but even a simple notebook can help you keep on top of your money. Look at your income and outgoings, and if there are any outgoings that can be cut (like eating out regularly) then use that money to pay off your overdraft.
Move to an interest-free overdraft – if your current overdraft charges a high interest rate, see if you can move it to one with 0% interest. This will mean you won’t have to pay anything more than what you actually owe, making it easier to pay off your debt. However, overdrafts with 0% interest are only usually offered as a very short introductory offer, meaning you may only have a few months to pay off what you owe. Once the 0% rate expires, you’ll probably be charged a very high interest rate.
Move your debt to a 0% money transfer credit card – these cards allow you to transfer money from a credit card balance directly into your bank account, which could pay off your overdraft in full. Then, you can focus on paying off the card, with the benefit of 0% interest. Just make sure that you’re aware of the terms of maintaining that 0% rate, otherwise it could be much more expensive. You’ll also need to pass a credit check.
Talk to your bank – if none of these are an option for you, it’s best to just speak to your bank account provider. The Financial Conduct Authority (FCA) states that banks should treat their customers fairly, which means you may be able to explain your situation and come to an arrangement, or get advice on how to manage your debt more effectively.

You can find more advice on how to pay off your overdraft here.

Frequently asked questions

Can I switch banks if I’m overdrawn?

Yes, it’s possible to switch banks if you’re overdrawn, but banks will most likely assess your personal finances and credit score before accepting your application. Banks also include tools on their websites to help you assess your eligibility for an overdraft with them before you apply.
Before you make the switch to a new bank, shop around by comparing current accounts with overdrafts. As well as the EAR, check out the charges and rules for each account to ensure you’re getting a deal you’re happy with. Using our price comparison tool, you can start comparing current accounts in minutes.

Can my overdraft be removed?

One reason why an overdraft isn’t recommended for long-term borrowing is that it’s not guaranteed. Your bank can remove your overdraft at any time, without notice. This could mean that any cheques or direct debits go unpaid – and you then can be charged additional fees for bounced payments. That’s why it’s important to keep track of your current account and spending.
 
However, if the bank removes your overdraft without warning and you’re charged, you may have grounds to complain. If you aren’t satisfied with your bank’s response, you can take your complaint to the Financial Ombudsman Service.

How do I check my overdraft?

The best way to keep an eye on your overdraft and spending is to regularly check your current account. You can do this by:

downloading the mobile banking app provided by your bank
Setting up a text alert for when your balance is getting low
making sure you read any letters from your bank straight away

How do I extend my overdraft?

Most banks will give you the option of extending an existing overdraft. In many cases, you can do this yourself via the bank’s mobile banking app, over the phone or at your local branch.

Can I get an overdraft as a student?

Yes, you can. In fact, many banks offer favourable, authorised overdraft conditions for student accounts. Many offer UK students an interest-free arranged overdraft of up to £3,000. Of course, that’s assuming you keep within your limit and you’ll be able to pay it back once you’ve completed your studies.

What are the alternatives to an overdraft?

If you use your overdraft for occasional spending, a better alternative might be a 0% purchase credit card. This could give you a fixed length of time to pay off the debt gradually without paying interest.

For longer-term borrowing and larger purchases, you might want to consider a personal loan. Repayments are spread over a fixed period of time and are usually for a fixed interest rate, which could help you budget.

Where can I get help if I am struggling to pay off my overdraft?

The first people to talk to, if you’re struggling to pay off your overdraft, is your bank account provider. Do this as soon as possible, as the sooner you reach out for help, the more likely they’ll be able to offer it to you. Explain your situation and they may be willing to either come to a new arrangement with you, offer you a potentially cheaper loan option, or at least provide you with advice on how to manage your debt more effectively.

Other than your bank, services like Citizens Advice, the National Debtline and StepChange are all freely available to offer debt advice.