What is an overdraft?
In simple terms, being overdrawn, or using an overdraft, is 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- Unauthorised overdraft – this is where you haven’t agreed an overdraft facility with your bank in advance and have withdrawn more money than you have in your account, or you have taken out more than your authorised overdraft limit.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 with fee-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.
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.