How to pay off your overdraft

How does an overdraft work?

An overdraft lets you borrow money through your current account by spending more than you have in it.

For example, if you have a balance of £200 and you spend £250, you’re £50 overdrawn. You’re borrowing that extra £50 from the bank, which will charge interest on it.

If you arrange an overdraft limit in advance with your bank, you’ll have a pre-agreed amount you can dip into if needed. Going over this limit may mean payments are declined.

An overdraft can be helpful for short term cash flow or emergencies, such as getting a broken boiler fixed. But it shouldn’t be considered as a long-term borrowing solution.

Why is it good to get out of an overdraft?

An overdraft is a form of debt. It can leave you in a vulnerable situation if you get stuck in a cycle of being permanently overdrawn.

Here’s why it’s important not to become too reliant on an overdraft:

Overdrafts are very expensive

Typical overdraft interest rates are around the 35-40% mark – much higher than most other forms of borrowing. If you don’t take action to reduce your overdraft, the total you owe will keep growing because interest accumulates daily.

For example, if you’re paying 39.49% on a £500 overdraft, the interest owed would be £3.24 after seven days. After 60 days, it would be £28.13.

You can break the cycle of debt and start to save

If you’re not tied up in overdraft charges every month, you can ease some of the stress and worry that comes with being constantly overdrawn. You might even be able to free up a bit of extra cash.

Once all your bills have been paid, any surplus income could be put into a savings account that will earn you interest rather than charging you it.

It could boost your credit score

Regularly using your overdraft could affect your credit score, especially if you keep going over the agreed limit. It signals to lenders that you may be struggling financially. This could make it more difficult and expensive for you to borrow in future.

Staying within the limits and taking steps to clear your overdraft could improve your credit score as it suggests you can manage money responsibly.

How does an overdraft get paid back?

An overdraft is paid back simply by putting money into your current account to reduce the negative balance.

Unlike with credit cards and loans, there’s no formal repayment structure. It’s up to you to manage your finances and make sure you pay back what you’ve borrowed, plus any related interest.

Setting a target to reduce your overdraft each month is a good way to keep motivated towards getting back in the black.

What are the options for paying off your overdraft?

There’s a number of different ways that could help you tackle the overdraft challenge head on:

1. Repay your overdraft gradually by budgeting

First, look at your monthly expenses by checking your current account. Separate them into:

• Essential costs like utility bills, rent/mortgage, food and transport

• Non-essential costs like entertainment, eating out and designer clothes.

Look for opportunities to cut back, from seeing if you could save money on energy bills to spending less on takeaways.

We’re not saying you have to forego every treat, but by drawing up a budget you can plan better and try to make inroads into your overdraft bit by bit.

2. Use your savings to pay off your overdraft

If you have money in a savings account, it can make financial sense to use it to reduce or clear your overdraft. Even with the best savings rates, the interest you’re earning is likely to be much lower than you’re paying on your overdraft.

This is often the right approach for those with enough money saved up to clear their overdraft and still have some left to act as a buffer in case of emergencies.

Once your current account is back in the black, you could arrange to pay yourself back and top up your savings with a regular payment every month.

3. Move to a cheaper overdraft

You may be able to lighten your financial load by switching to a current account with a cheaper overdraft than you’re currently paying, ideally 0%.

Although interest-free overdrafts still exist, particularly for students, they’re far less common than they used to be. Even if you do find one, the 0% offer may be for a short time only or on a small amount of money, so check the terms carefully.

It’s possible to switch accounts even if you’re overdrawn, although new providers are likely to take your credit score into consideration and review how you’ve been managing your overdraft to date.

4. Move your overdraft debt to a 0% money transfer card

A 0% money transfer credit card allows you to transfer money straight into your current account and pay off your overdraft debts immediately.

You’ll then owe the money to the credit card provider, but at 0% interest – although you’ll usually pay a fee of about 3-4% of the transferred amount.

The interest-free offer will be time-limited, typically up to 14 months. After this, the card’s standard interest rate will apply. So, it’s important to try to clear the balance before the 0% period ends.

Remember, this option still involves taking on debt, so think carefully before going ahead.

5. Move bill dates to minimise interest

To reduce the amount of interest you’re paying on your overdraft, try to schedule all your direct debits and standing orders to go out just before you get paid.

For example, if your salary goes into your account on the 27th of the month, try scheduling bill payments for around the 22nd.

This keeps your balance higher for longer, meaning that you should spend less time in the red. Just be careful not to spend too much before the bills start rolling in.

6. Ask your bank for help

Banks often offer tailored support for customers struggling with overdraft debt, so don’t be afraid to talk to your provider. They may be able to help you manage your debt more effectively. Options include:

• Agreeing a structured repayment plan

• Reducing your overdraft limit as you pay it off

• Temporarily suspending or reducing your interest rate

• Switching the overdraft to a lower-interest loan.

By taking proactive steps to regain control of your finances, your bank may be more sympathetic to your plight.

Who else offers overdraft payment advice?

Although your bank is a good first port of call, you can also get free advice from various debt counselling services.

These include:

• Citizens Advice

• National Debtline

• StepChange.

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If you’re looking to take control of your overdraft by switching your bank account, we can help you search for suitable products.

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