How to pay off your overdraft

How does an overdraft work and what can you do to get out of debt? This guide will help you explore the options for paying back what you’ve borrowed and managing your money better.

How does an overdraft work and what can you do to get out of debt? This guide will help you explore the options for paying back what you’ve borrowed and managing your money better.

Anelda Knoesen
From the Money team
10
minute read
Do you know someone who could benefit from this article?
Posted 27 AUGUST 2021

How does an overdraft work?

An overdraft is a way of borrowing money through your current account.

If you’ve got a current account that offers an overdraft, when you spend more than you’ve got in your account, you enter overdraft territory. 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. If you don’t have an overdraft on your current account, the bank will very likely refuse to make the payment.

Ideally, an overdraft limit is approved in advance by your bank. This means you have permission to overspend up to a pre-agreed amount over a set period.

You’ll have to pay interest on your overdraft, unless you have an agreed overdraft buffer, which may be interest-free if you stay under a certain amount. Always check the lending criteria carefully.

As a way of accessing money on a short-term basis, or in an emergency, an overdraft can be a godsend. For example, if your car breaks down and you need it back on the road fast, an overdraft could cover the cost of repairs and keep you afloat until payday. An overdraft could also help you avoid fees for bounced or return payments due to a lack of funds in your account.

For some people, even just having an arranged overdraft on standby provides valuable peace of mind, even if it’s never or rarely used.

But if you go over your agreed overdraft limit without renegotiating with your bank; or you overspend without organising an overdraft at all; or you’re using your overdraft every month without fail, it could affect your credit score. This could make it harder and more expensive for you to borrow in future.

How can I avoid having to use an overdraft?

Don’t spend more than you have coming in. Budgeting apps are available to help you with this.

We have a bills checker tool in our app where you can see all your income and bills in one place, with the option to compare for better deals on your utilities. We can also help you see if you might be paying more for your bills than people in your area. Our bills calculator will give you a quick indication of your potential to save more.

What’s really essential for avoiding an overdraft is to be aware of what bills are coming up. If you know you have a big bill coming in, then by spending less on non-essentials you’ll potentially have enough money to pay it.

How much will I be charged in interest on my overdraft

The way banks charge for overdrafts changed in April 2020.

  • Interest on all overdrafts is now charged at a single annual interest rate (APR)
  • There are no daily or monthly fees for using your overdraft
  • The same interest rate is charged for arranged and unarranged overdrafts.

The changes to charges mean anyone going into the red unexpectedly could be better off, or see no change, in the cost to them as there are no daily or monthly overdraft fees to pay.

But the interest rate banks are charging on overdrafts is typically pretty hefty on standard current accounts. The rates vary depending on the bank you’re with. They start at around 20%, but you may be charged almost 40% – far more than most credit cards.

Your credit history – which shows how well you manage your finances – is likely to have an impact on the size of overdraft your bank will allow, and potentially how much interest you have to pay. Read our guide to free credit checks to find out how healthy your credit score is.

How does an overdraft get paid back?

There’s no formal repayment structure, which can make it more difficult to get out of your overdraft. It’s up to you to manage your finances and make sure you pay back what you’ve borrowed, plus any related interest.

To budget to pay off an overdraft, it can be helpful to think of it this way: the maximum amount you’re overdrawn just before pay day is the amount you need to pay back.

Work out how long it’ll take you to repay that money plus any interest. For example, you’re £300 overdrawn at the end of each month. Could you spend £100 less every month for three months to get you back to level pegging, then the next month avoid spending the equivalent of whatever interest is still owed?

If you can’t spare that much, you could reduce your overdraft by £50 a month for six months and then pay the interest.

Setting a target to reduce your overdraft each month can help you achieve your goal.

If you find yourself going repeatedly into your overdraft, you may have to look into cutting back on your spending.

What are the options for paying off your overdraft?

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

1. Repay your overdraft gradually by budgeting

There are apps that can make this easier, but a spreadsheet or even notes in a notebook can work just as well and help you pay off your overdraft over time.

First, look at your monthly income versus expenses over a three-month period by checking your bank statements. What are your essential costs – for example bills, rent/mortgage, food and transport – versus non-essentials, like entertainment, eating out and shopping?

From saving money on energy bills and broadband charges to spending less on takeaways, pausing a gym membership or putting off getting that new pair of trainers, you can usually spot opportunities for cutting back.

Drawing up a budget will help you see where your money is going and where to make savings.

Other budgeting tips include:

  • Overestimating rather than underestimating the amount you spend.
  • Changing the dates on your direct debits so the money goes out just before you get paid. You’ll spend less time in the red, meaning fewer charges.
  • Factoring in quarterly and annual payments (not just monthly bills) like annual insurance renewals or your TV licence, for example.
  • Putting money aside for special occasions, for example birthdays, holidays or Christmas.
  • Having a plan to keep you focused, for example, repaying a set amount per month until your overdraft is paid off.

For more useful tips, check out our guide to saving money on your bills and spending.

2. Use your savings to pay off your overdraft

While it’s reassuring to have money in a savings account, the amount of interest you’re gaining is likely to be a fraction of what you’re paying in overdraft fees. Always think about your overall financial situation before making any big decisions, but it may make sense to use those savings to pay off your overdraft debt instead.

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 an interest-free overdraft

The cost of interest on an overdraft can be hundreds of pounds each year, so finding a current account with 0% interest can lighten the financial load considerably.

It’s possible to switch accounts even if you’re overdrawn, although new providers are likely to take your credit score into consideration, as well as reviewing how you’ve been managing your overdraft to date. You’ll need to agree an overdraft with your potential new bank before switching.

Remember, that 0% offer may also be for a limited time only – for example a year – but it gives you a chance to pay back what you owe, interest free. If you need longer, you can look at switching again in a year’s time or whenever the offer expires.

You may also need to have a certain amount of money going into the account each month to keep it fee-free.

Always read the terms and conditions carefully before you sign up with a new provider.

4. Move your overdraft debt to a 0% money transfer credit 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 transfer fees may apply.

You’ll normally have a limited period of time to take advantage of this 0% interest offer – and the better your credit rating, the more time you’re likely to be offered. You may have as long as 28 months to enjoy the benefits, after which time, interest applies.

5. See if you can increase your income

Think about ways you could boost your income – even if only for a short while until the overdraft is paid off. Can you sell things you no longer use on eBay or an equivalent? How about taking on extra overtime or a part time job? Have you got a side ‘hustle’ that you can exploit?

Depending on your circumstances, it may also be worth checking whether you’re claiming all the benefits you are entitled to.

6. Talk to your bank about the best way to pay off your overdraft

The Financial Conduct Authority (FCA) expects banks to treat their customers fairly. If you talk to your bank or building society, they may be able to help you manage your debt more effectively – perhaps by offering you a loan at a lower interest rate.

You could also arrange for your overdraft limit to be reduced over time as you pay it off. This could stop you being tempted to dip into it again, spoiling the good progress you’ve been making.

Your bank may also be able to waive or cancel interest payments or reduce your interest rate for a certain period of time, depending on your financial status. But it may expect a commitment from you in return. For example, you may have to follow a repayment schedule so you’re free from overdraft debt by a certain date.

Frequently asked questions

How can I rely on my overdraft less?

Many people underestimate how much they use their overdraft facility, so your first step is to keep an eye on your balance and notice if you’re edging towards the red again.

To keep track of your spending, you might find it helpful to:

  • Use mobile banking and download your bank’s app onto your phone.
  • Ask your bank to text you balance updates on a regular basis.
  • Set up text alerts to nudge you when your balance is low or goes below a certain figure.

If your bank enables it, put a limit on your spending to help avoid temptation.

Should I get a loan to pay off my overdraft?

Getting a loan to pay off your overdraft only makes sense if it has a lower rate of interest than your overdraft. If you’re thinking of going down this path, make sure it won’t cost you more in the long run.

But if you’ve got multiple debts from store cards, credit cards and loans, a debt consolidation loan might make your life easier. It combines all your existing debts into one monthly payment, swapping multiple lenders for just one.

This can make it easier to pay back what you owe, as well as reducing the total amount of interest. Sticking to the regular, monthly payments can also help improve your credit rating. Be aware though that extending the term of your debt can mean more interest, and cost more, in the long run. Plus, there may be early repayment charges to pay.

Can I get a bank account without overdraft facilities?

If you find it hard to control your spending or your credit score has taken a bashing, a basic bank account may be the answer.

They’re designed for people who aren’t eligible for standard bank accounts, although anyone who meets the criteria can be accepted. There’s no overdraft facility, so if you overspend, your payment will be denied.

Aside from my bank, who else offers overdraft payment advice?

Although your bank or building society is a good first port of call, you can also get free advice from a number of independent third parties – especially if you’re not sure about what you should say to your bank.

These include:

AutoSergei™: An Open Banking bill checking service

Compare the Market’s AutoSergei service includes an online bill checker that uses Open Banking technology. It searches through your transactions and helps you to spot whether your bills have gone up or down, letting you know if and when there are opportunities to switch and save.

See how to keep your money in check with Auto Sergei