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An overdraft is a type of credit that allows you to spend more money than you currently have available in your bank account. It is normally attached to a current account and can provide access to additional funds up to an agreed limit.
Overdrafts can be useful for managing short-term cash flow or dealing with an unexpected expense. However, the money you use is borrowed and will need to be repaid. Depending on your bank and account, you may also pay interest on the amount you borrow.
Because overdrafts are so closely connected to everyday bank accounts, it can sometimes be easy to forget that you are borrowing. Understanding how overdrafts work, what they cost and how they can affect your finances can help you decide when — or whether — using one is appropriate and also whether an alternative form of credit, such as a credit line, may be more suited to you.
An overdraft allows your current account balance to fall below £0.
For example, if you have £20 remaining in your account and make a £50 payment, you would use £30 of your overdraft.
Unlike a personal loan, you do not normally receive a separate lump sum of money. Instead, your overdraft becomes available through your existing bank account and you can use your normal debit card, direct debits and bank transfers while overdrawn.
Your bank will usually set a maximum amount you are permitted to borrow. This is your overdraft limit.
When money is subsequently paid into your current account, it reduces the amount you owe. For example, if your balance is -£250 immediately before £1,500 of wages are paid into your account, your new balance would be £1,250.
This automatic repayment can be convenient, but it can also contribute to a cycle where somebody repeatedly starts each month with less of their salary available because some of it is immediately being used to clear the previous month's overdraft.
There are two main types of overdraft.
An arranged overdraft is agreed with your bank in advance. Your bank gives you permission to borrow up to a particular limit and explains the interest rate and other terms that apply.
You may be offered an overdraft when opening a current account, or you may be able to apply for one later.
Because an overdraft is credit, your bank will normally consider your financial circumstances when deciding whether to offer one and what limit to provide.
An unarranged overdraft occurs when you spend more than the money available in your account without having a sufficient arranged overdraft in place.
For example, you might have an arranged overdraft of £300 but a payment takes your balance to -£320.
Alternatively, you may not have an arranged overdraft at all.
Banks have different policies around what happens in these circumstances. A payment might be declined, or the bank may allow it and take your account into an unarranged overdraft.
Check your bank's current terms to understand exactly what happens if you exceed your agreed limit.
There is no single interest rate for overdrafts. The cost depends upon your bank, current account and the terms you have been offered.
This makes it important to look beyond other current-account features when comparing bank accounts. An account offering cashback or another incentive is not necessarily the best option if you regularly use an overdraft and its borrowing costs are higher.
One major change to the UK overdraft market came into force in April 2020, following reforms introduced by the Financial Conduct Authority (FCA).
Previously, overdraft pricing could include a complicated combination of daily fees, monthly fees and interest. The reforms were designed to make overdraft pricing easier to understand and compare, including requiring banks to advertise arranged overdraft prices using an annual interest rate. These reforms were significant for both arranged and unarranged overdraft users.
The exact rates charged by individual banks can change, so always check the current terms of your account rather than relying on a general example or an old advertised rate.
They can be.
Whether an overdraft represents an expensive way to borrow depends on your interest rate, how much you borrow and how long you remain overdrawn.
An overdraft used occasionally for a small amount and repaid quickly may cost relatively little. Regularly borrowing hundreds of pounds and remaining overdrawn for much of the month can result in considerably more interest.
This is one reason overdrafts are generally better considered as a form of short-term borrowing rather than an extension of your monthly income.
Before using one, consider how much the borrowing will cost and when you realistically expect to return your account to a positive balance.
One of the biggest advantages of an arranged overdraft is convenience. Once the facility is available, you do not need to submit a new credit application each time you use it.
It is also flexible. You only use the amount required rather than having to borrow a predetermined lump sum, and money entering your account automatically reduces your outstanding balance.
Other potential benefits include:
This flexibility is one of the main reasons overdrafts can work well for occasional cash-flow shortages.
However, convenience should not be confused with free money.
The close relationship between an overdraft and your current account can also be its biggest disadvantage.
Because you continue spending through the same debit card and bank account, it can be surprisingly easy to enter your overdraft without consciously making the decision to borrow.
Regular use can then become habitual.
If £300 of your salary immediately clears an overdraft every payday, for example, you effectively begin the following month £300 behind. If your normal expenditure hasn't changed, you may gradually use the overdraft again before your next payday.
Other potential disadvantages include paying interest, becoming dependent on the facility and having less of your salary available each month.
The bank may also review or change your overdraft limit, meaning it should not be treated in the same way as savings or your own money.
Using an overdraft occasionally is not necessarily evidence of a financial problem. The more important question is whether you can comfortably repay what you borrow.
Regularly reaching your overdraft limit, spending most of every month overdrawn or finding that your salary only temporarily clears the balance can be warning signs that the overdraft has moved beyond managing an occasional cash-flow shortage.
Persistent monthly overdraft use is a good reason to review your spending and budget.
Look at what is causing the shortfall. If your essential expenditure is consistently higher than your income, further borrowing is unlikely to solve the underlying problem.
Start by knowing your limit and the interest rate you are being charged.
Online and mobile banking can make this much easier because you can monitor your balance regularly rather than discovering at the end of the month that you have spent significantly more than expected.
Balance alerts can also be useful if your bank provides them.
Most importantly, remember that your overdraft limit is not a spending target. If your bank allows you to borrow £1,000, that does not mean borrowing the full £1,000 is affordable or appropriate.
Before using an overdraft, consider how the borrowing will fit into your next month's budget and whether you will have enough remaining income after repaying it to cover your normal essential expenditure.
An overdraft is a form of credit, so your use of one can form part of the financial information lenders consider.
Simply having an arranged overdraft does not automatically mean you have a poor credit history. However, lenders like us are not interested in a credit score alone. When you apply for a credit line with us, we will consider information from your credit report alongside affordability and other factors.
Heavy reliance on an overdraft, exceeding agreed limits or experiencing wider financial difficulties could therefore be relevant when you apply for credit.
If you are planning a significant credit application such as a mortgage, it can be particularly useful to understand what information appears on your credit report and make sure it is accurate.
Read our Borrowing With A Bad Credit Score Guide for more information.
Student current accounts often include overdraft facilities designed specifically for people studying at university.
A key attraction is that some student accounts provide an interest-free arranged overdraft up to an agreed limit. However, offers, eligibility requirements and limits vary considerably between banks and can change from year to year.
Even when an overdraft is interest-free, it remains borrowed money.
It can be tempting to think of a £1,000 student overdraft as an extra £1,000 in your account, but the balance eventually needs to be repaid.
Students using an overdraft should therefore monitor their balance, avoid exceeding their agreed limit and check how the account changes after graduation.
An overdraft can provide a financial buffer during university, but the money still has to be repaid.
Student accounts will usually transition into graduate or standard current accounts after you finish studying.
The terms may change during this period, including the amount you can borrow without paying interest.
Do not assume an interest-free student overdraft will remain interest-free indefinitely. Check when your student account changes, what your new overdraft terms will be and whether you need to begin gradually reducing the balance.
Planning ahead can make repaying the overdraft easier than waiting until an interest-free period ends.
If you regularly live in your overdraft, reducing it can seem difficult because every payday simply brings your account back towards £0 before your normal spending begins again.
The first step is to understand exactly how much you're using.
Review several months of bank statements and identify your typical balance immediately before payday. If you are consistently £400 overdrawn, for example, treating that £400 as a debt you want to gradually reduce can be more useful than thinking of your overdraft as part of your available monthly balance.
You do not necessarily have to clear everything at once. If affordable, reducing your reliance on it gradually can still move you in the right direction.
Start with your budget. Look at your income, essential expenditure and non-essential spending to determine whether there is an affordable amount you could put towards reducing your overdraft each month.
You could also speak to your bank. If you are finding your overdraft difficult to manage, do not wait until the situation becomes more serious. Your bank may be able to explain what support is available.
Gradually reducing an overdraft limit as the balance comes down is a good way to make sure you do not immediately reborrow what you have repaid.
If you cannot afford essential bills or your borrowing is becoming unmanageable, consider seeking free, independent debt advice.
An overdraft is primarily suited to short-term borrowing.
If you are using one to cover the same essential expenses every month, borrowing increasingly large amounts or struggling to return your account to credit, taking on additional borrowing may make your financial position more difficult rather than solving the problem.
Similarly, an overdraft is not automatically the cheapest way to borrow simply because you already have access to it.
Consider the cost, repayment structure and purpose of the borrowing before deciding.
Different credit products work in different ways, and the right option depends on what you need to borrow, how long you need it for and what you can afford to repay.
A credit card provides revolving credit through a separate card account. A personal loan usually provides a fixed amount that is repaid through scheduled instalments. Borrowing from friends or family may also be an option in some circumstances.
Another alternative is a credit line. Like an overdraft, a credit line is revolving credit, meaning approved customers can access funds up to an agreed limit rather than applying for a new loan each time.
Both products can provide flexible access to credit, but they are not the same product.
An overdraft is normally attached directly to your current account, whereas funds withdrawn from a credit line are transferred into your bank account and repayments are managed separately. Polar Credit provides a revolving credit line rather than an overdraft.
If you're considering alternatives to an overdraft and want to understand the differences, read our dedicated Credit Lines vs Overdrafts guide before deciding whether either form of borrowing is suitable for you.
No form of borrowing is right for everyone.
An arranged overdraft can provide a convenient buffer for an occasional short-term cash-flow shortage, but regular reliance on one can make it harder to keep track of where your own money ends and borrowing begins.
Before borrowing, ask yourself:
If you already have overdraft debt that you're struggling to repay, applying for additional credit is not necessarily the answer. Speak to your bank and consider free debt advice if you need support.
Borrowing With A Bad Credit Score
For more helpful information about managing money, borrowing and different financial products, visit the Polar Credit Info Hub.