Overdrafts are commonplace for most people with a current account and they can help you manage your finances in a variety of ways. It’s important to remember, however, that overdrafts are still credit and so your overdraft usage is recorded on your credit file and your bank will expect you to repay the funds every month. Different banks offer different interest rates and charges for their arranged and unarranged overdrafts, so again like other credit, it’s a good idea to look around first before opening a new current account. There may be introductory offers, cashback rewards and even other benefits like mobile phone insurance available across different banks.
Overdrafts allow you to borrow money by letting you spend more money that you have in your bank account. Typically, overdrafts are attached to current accounts. You might have an interest free overdraft limit and then an interest charging overdraft limit. The overdraft limit that has been agreed with your bank is your “arranged overdraft”. If you spend more than your arranged overdraft limit, you enter an “unarranged overdraft”. There tend to be higher interest rates or daily charges for using an unarranged overdraft, though there are now caps on the amount banks can charge for overdrafts.
Sometimes you may find your current account comes with an interest free arranged overdraft. The credit limit is usually between £50 and £250. If you would like a larger overdraft, or your current account does not automatically come with an overdraft, you simply need to contact your bank to apply. They will likely run credit checks and affordability assessments as overdrafts are a type of credit and the bank needs to make sure that borrowing this way will not land you in financial difficulty, however it tends to be a relatively quick application process.
While overdrafts are a standalone type of credit, one of the best ways to think about them is like a loan. You are borrowing money which has to be repaid at the end of your statement period. Overdrafts can help you manage unexpected payments or emergency bills with little difficulty as you can use your normal debit card but be mindful that when your salary is paid in, the funds will be allocated to your overdraft first. This means if you owe £250 on your interest-free overdraft, and you receive your monthly wages of £1000, you will actually only have a positive balance of £750.
It can be easy to get trapped in a cycle of overdraft spending. It can help to download mobile banking so you can regularly check your balance and your transactions. This can help keep you aware of how much money you have left and if you have already entered your overdraft. Remember that your overdraft is borrowed funds, not just an extension of your current balance. Using overdrafts for small, unexpected purchases (when you haven’t got time to reshuffle your finances in advance) can be a good way to use this type of credit, as long as you make adjustments to your future budget to accommodate the costs in your next wages.
There are many alternative borrowing options if you don’t want to use your overdraft or if your overdraft is not sufficient for your borrowing needs. Instant payday loans are quite a common way to meet emergency payments, especially if you have a low credit score or poor credit history. If you want longer term access to credit, there are a range of purchase and balance transfer credit cards – even if you have a bad credit file – that could help you manage your finances from time to time. As well as credit cards, credit lines can also be a useful line of credit to have; instead of using a card to make payments, you simply withdraw the cash from your credit line account directly into your bank account.
When looking for ways to borrow, it’s important that you find an option that is suitable for your needs and for your circumstances.
Like a personal line of credit loans can also be a reasonable way to borrow if you need a quick resolution to a temporary problem. Where lines of credit, like overdrafts and credit lines, can be preferable are if you want reassurance that you have access to credit whenever you might need it. Loans are fixed term agreements, so you apply once, receive the money once, and repay the balance over a specified period. A line of credit is a much more flexible agreement, typically with minimum payments, but as long as you stay within the terms of the agreement, you can borrow and withdraw as often as you need to.
Check out our other great content in our Info Hub, with articles about the different types of credit products, money management tips and help with saving money!