Overdrafts Explained: Costs, Rules and Alternatives

What is an overdraft?

When your balance falls below zero, you are overdrawn. The bank has effectively lent you the difference. Overdrafts are repayable on demand, so in theory the bank can ask for the money back at any time, though in practice they usually allow you to repay over time and review your limit regularly.

Arranged and unarranged overdrafts

What it can cost

Overdraft costs are now typically expressed as an annual rate. Overdraft rates are often high, with many standard accounts charging 30% EAR or more, although some accounts charge much less. Many people think they only pay for the amount they borrow, and they do. But because interest accrues daily, staying overdrawn for months adds up quickly.

Effect on your credit file

Your use of an overdraft may be seen by lenders. Using the overdraft heavily or regularly can suggest you are struggling to manage money, especially if you are near your limit. A lender may see this when you apply for a mortgage or loan. Going over your arranged limit, or having payments returned, may be considered negative. If you use Open Banking data when applying for credit, the lender may see more of your account activity. Our guide to credit scores explains what is recorded.

Who can get one

Overdrafts are offered with most current accounts, subject to a credit check. Students and graduates often qualify for interest-free overdrafts. You may have an automatic limit set after a period of time with the account. Banks must assess whether you can afford it, and must contact you if they think you are in financial difficulty.

The risks

• Debt becoming permanent. If you are overdrawn every month, the overdraft has become a long-term loan at a high cost.
• Limits can change. A bank can reduce or remove your limit. You could be asked to repay quickly.
• Returned payments. If you exceed your limit, direct debits and standing ordersStanding orderA standing order is an instruction to your bank to pay a fixed amount to a particular account on a regular schedule.Read more → can fail, causing late fees from billers.
• Hidden spending. Because overdraft money looks like your own balance, it is easy to forget that you are borrowing.
• Effect on mortgage applications. Lenders look at your bank statements for signs of reliance on the overdraft.

How to get out of your overdraft

1. Find out what it costs. Check the rate, and how much interest you pay each month.
2. Set a target. Divide the amount by a number of months and make that your monthly repayment goal.
3. Cut spending. See how to stop overspending and how to cut household bills.
4. Move your salary or income to pay the overdraft first, if you can.
5. Consider a cheaper loan. A 0% balance transferBalance Transfer Credit Cards ExplainedHow balance transfer cards work in the UK: 0% periods, transfer fees, eligibility, risks and how to use one to pay down card debt without making things worse.Read more → or money transfer card, or a lower-cost personal loanPersonal Loans Explained: What to Know Before BorrowingHow UK personal loans work: APR, fixed repayments, secured versus unsecured, early repayment charges, eligibility checks and how to borrow safely.Read more →, could cost less, but only if you can stick to a plan. See balance transfers and personal loans.
6. Ask your bank for help. Banks should support customers in financial difficulty, for example by agreeing a plan or reducing charges.
7. Get free advice if you are struggling. StepChangeStepChange Explained: What It Does and How It WorksWhat the debt charity StepChange offers, how its free debt advice and debt management plans work, who it suits and what to expect when you contact them.Read more →, National DebtlineNational Debtline: How It Works, When to CallWhat National Debtline is, who runs it, what it can help with, how to get free advice by phone, webchat or online tools, and what to expect.Read more → and Citizens Advice can help you build a plan.

Choosing a current account

If you use an overdraft, compare accounts on the overdraft rate, any interest-free buffer, and how the bank treats customers who are in difficulty. Providers must show a standard overdraft rate for comparison, and many offer a tool that lets you check how much a given amount would cost in a month. Do not choose an account only for a switching incentive if the overdraft rate is much higher. The Current Account Switch Service moves your direct debitsDirect debitA Direct Debit is an instruction to your bank to let a company collect varying amounts from your account on agreed dates.Read more → and payments for you, which makes changing less risky.

Alternatives to an overdraft

• A small emergency fund; see how to build one
• A credit union loan for short-term needs
• A 0% purchase credit card for planned purchases that you can repay in the offer period
• A Budgeting Advance from the government, if you receive certain benefits
• Talking to the biller, since many will agree a short delay

Can the bank take money from my account to pay an overdraft?

If you have another account, such as a savings account, with the same bank, the bank may be able to use the money in it to reduce your overdraft, which is known as set-off. Banks are expected to tell you before doing this, except in limited circumstances. Check your account terms.