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Overdrafts

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What are they?

Overdrafts are effectively temporary loans that kick in should the balance on your bank account fall below zero. There's usually a limit of between £100 - £500 and rates of interest can be high, as can additional fees (especially if you haven't agreed the overdraft with your bank beforehand).


Types

There are two types of overdraft:

AuthorisedUnauthorised

This is when your overdraft is within a limit pre-agreed by your bank, e.g. £250. Banks do not normally charge you any fees for using this overdraft, but might charge annual interest of up to 20% or more.


Features

Some, but not all, banks may offer one or more of the following overdraft features.

BufferGrace Period

If you have a 'buffer' you can slip into an agreed amount above your authorised overdraft without the usual penalties applying. However, you may still have to pay interest and a buffer fee. Buffers vary between banks, but typically range from £10 to over £100.


Understanding the rate

Overdraft intrest is quoted as an Effective Annual Rate (EAR). This takes into account the interest you could end up payingon interest, i.e. compounding.

For example, if annual overdraft interest is charged at 20% a year but calculated daily, the EAR would be 22.1%.


Should I use one?

Provided you stick to your authorised overdraft for short periods of time, then an overdraft can be an excellent way to cope with the odd financial hiccup. However, straying into the realms of unauthorised overdrafts can be very costly.

If possible, it's far preferable to instead use a credit card with a 0% or low introductory rate to tide you through such times. If you think you'll be overdrawn beyond your authorised limit for more than a month then consider a flexible bank loan instead, as it could end up being cheaper. However, bear in mind that many banks have a £1,000 minimum loan amount and you'll need to be able to afford the repayments.


Jargon

Here's some of the more common overdraft jargon you might come across:

JargonMeaning
Authorised OverdraftWhen your bank account has a negative balance, with the bank's permission. Terms are usually favourable compared to an unauthorised overdraft.
BufferAn agreed amount above your authorised overdraft into which you can slip without the usual penalties applying.
OverdraftA temporary loan that kicks in should the balance on your bank account fall below zero.
Unauthorised OverdraftWhen your bank account has a negative balance, without the bank's permission. This can result in stiff charges and high interest.