What is an overdraft?
In simple terms, you are overdrawn, or using an overdraft, when you spend more money than you have in your bank account.
However, there are two kinds of overdraft, and the difference between them is key:
- Authorised overdraft - with an authorised overdraft, you have a set overdraft limit which you pre-arrange with your bank. You will usually have to pay interest or a fee in return for making use of the overdraft facility, although some banks do provide interest-free overdrafts.
- Unauthorised overdraft - this is where you haven't agreed an overdraft facility with your bank in advance and have withdrawn more money than you have in your account, or you have taken out more than your authorised overdraft limit. Unauthorised overdrafts are to be avoided at all costs because they are often subject to charges and fees which can be very expensive.
When to use an overdraft
Overdrafts can be a good way to borrow small amounts of money for a short period of time, but most overdrafts are not a very effective way of borrowing in the long-term, because they may come with a higher rate of interest than some loans and even some credit cards.
Even if your current account is always in credit, it can be a good idea to have an overdraft facility arranged with your bank. Having an overdraft 'just in case' can act as a useful buffer to protect you from fees and charges for unauthorised borrowing if you ever accidentally overspend or find yourself in a situation where you need a little extra money right away. Accounts like the Co-operative Bank's Current Account Plus which comes with a fee-free overdraft up to £200, and NatWest's Current Account Plus, which has a £100 interest free overdraft, are ideal for this kind of situation.
What to do if you rely on your overdraft
If you are frequently overdrawn, or often go overdrawn without authorisation then you should really check to see if you are getting the best deal on your current account, as you could be paying far more than you need to in interest or charges.
Alliance and Leicester's Premier Direct and Premier current accounts both come with an interest free overdraft for the first year after you open your account, which could give you the breathing space you need to cut your overdraft down to size. After the first year, you pay a usage fee of 50p a day, up to a maximum of £5 a month - making it one of the best value accounts if you rely on your overdraft. Find out more and apply now.
If you have a big overdraft and you can't or don't want to switch to an interest-free overdraft account, you could look at switching your overdraft to a cheaper type of borrowing. You could look at getting a personal loan at a lower rate of interest than you are paying on your overdraft. Another alternative is a credit card that offers a good deal on money transfers, like the MBNA Platinum Plus. The card offers 0% on money transfers to your current account for 13 months (a 4% handling fee applies) if you make the transfer within the first 90 days of opening your account. This could be a good way of clearing your overdraft if it's costing you a lot, and gives you a generous period to pay off the balance. The interest rate on money transfers after the 13 month interest free period is up is 19.9% APR and the standard rate on the card is 15.9% APR typical variable. Apply now.