The world of bank overdrafts can appear to be a perilous place — full of mysterious three letter acronyms, unwelcome fees and a sense, for me at least, that banks are profiting from my occasional need for some financial flexibility.
No wonder then, that many of us are left worrying about how much our overdrafts cost us and asking: what is my limit? When will I be charged? Where did that fee come from?
Maybe, like me, you’ve even found yourself stumbling into unknown territory with overdrafts, only to find answers to your questions when it’s almost too late and your bank account has been further depleted by monthly fees and overdraft charges. In these instances it can be more than stressful. Falling into a rut with your overdraft can leave you feeling stuck.
But does it have to be such a minefield? Turns out, no: no, it does not. And after a few years of figuring things out, here’s what I’ve learned about overdrafts: the costs, benefits, and how to turn what could be a bleak experience into something positive and useful.
We believe a transparent, understandable and easy-to-use overdraft is central to creating the best current account, to helping people see their money more clearly, and developing a healthier financial life.
But first, the basics. What is an overdraft?
To keep it simple: an overdraft allows you, the account holder, to take money from your account when there is no money in it.
In this sense, it is a short-term cash flow for when your bank balance falls below zero. Further spending dips you into your overdraft and it is intended more to keep your head above water until you next deposit money into the account, rather than a long-term loan.
However, most of us probably first experienced using an overdraft as a student. And because it’s an interest free overdraft, this can begin a slow slide into debt when a lack of income combines with a self-extended, year-on-year increase in how much you can borrow. In my case, it actually led to nearly 18 months of digging myself out once I’d got my first job, and my student overdraft went from being free to accruing overdraft interest and charges.
Now I tend to use overdrafts in the same way I use a credit card — paying off my overdraft like I do credit card bills. It’s more to ease any pre-payday panic or post-bank holiday anxiety (last one included). It’s a safety net, not a lifestyle. Because it’s important to remember that an overdraft is a form of debt as well, and it can rack up.
How much does an overdraft cost?
The cost of having an overdraft massively depends on which bank, what arrangement you have with your bank, and how much you borrow. With that in mind, we’ve done the maths here so you don’t have to — check out our calculator to compare different overdraft interest rates.
On top of this, there are three primary ways that you will be charged for an overdraft: some banks charge daily flat fees, while others charge interest (quoted as an Equivalent Annual Rate or EAR), and some have a combination of both. It’s also worth noting that for unarranged overdrafts, all banks are subject to a maximum monthly cap now — good news since reports suggested some unauthorised overdrafts were more costly than payday loans. However, these can still be as high as £50 or £70 (unless you’re with Starling, in which case the monthly maximum charge is £2).
Hang on, what’s ‘EAR’?
Good question. It’s the catchily named ‘Equivalent Annual Rate’: the rate of interest you would pay over a year if you were to remain overdrawn. An EAR is a common way of showing interest rates on overdrafts that you can use to compare different banks’ interest rates. Importantly, an EAR does not include the fees that some banks may charge you in addition to interest. Starling does not charge any such additional fees. We should add here that EARs are usually variable, meaning the banks can change them at any time as long as they let you know in advance.
So flat fees sound simpler?
To a point. Banks, both old and new, are currently making a great deal of noise about innovative overdraft charge structures and alternative figures to things like EAR, particularly daily flat fees. But these can end up being more costly if you’re not careful.
For example, if your overdraft has a 50p per day charge and you are overdrawn by £100 for 31 days, you will be charged £15.50. If your bank charges you using percentages rather than flat rate daily fees, the cost of your overdraft will differ.
Starling charge 15% EAR with no additional set up, usage or monthly fees, so if your Starling account is overdrawn £100 for 31 days, you will pay £1.27 in interest for this service. Of course, you could most likely borrow more than £100 for the same 50p per day fee, but maybe you don’t want to, or need to, so why take on more debt than you need?
And what about 'APR'?
This is the equally catchily named ‘Annual Percentage Rate’. Although the interest rate charged on a product might be quoted at, say, 12.5%, the APR might be greater at 17%. This is because any other costs, such as arrangement fees or monthly account fees, are captured and annualised into a single and comparable rate. This rate is a measure of the total interest and bank charges you will have to pay when taking out any financial product — be that an overdraft, credit card or car loan. So far, so good? An APR would be very helpful to be able to compare the different banks’ overdraft interest and charges, but you usually won’t find this so easily, if at all.
How does having an authorised/unauthorised overdraft affect how much it costs?
Let’s set one thing straight: regardless of what adjectives your bank uses authorised/unauthorised, planned/unplanned and arranged/unarranged overdrafts are, in effect, the same thing.
An authorised overdraft is one that you have agreed upon with your bank.
On the other hand, (you guessed it) unauthorised overdrafts are the opposite. They are not pre-agreed with your bank and usually occur because of slip-ups and last minute spending — either putting you into overdraft or letting you go over your agreed limit. Both can come with sting in the tail.
Using an unauthorised/unarranged overdraft often comes with additional charges and costs for being a few pounds over your limit. On a number of occasions, I’ve heard friends complain about going £1-2 into an unauthorised overdraft and ending up being charged more than the amount overdrawn. Which seems more than a little ridiculous. But when you realise that some UK high street banks charge as much as £6 a day above certain thresholds, it makes sense how this happens. They are subject to a cap (often around £80 or £90) but add on top that any bounced payments may come with further charges, and suddenly overdrafts aren’t a fun place to be.
At Starling, we pre-approve you for an overdraft when you open an account, after completing certain checks. If you accept it, you can then control your limit by scrolling it to a level that suits you and helps you stay in budget. But we also make a point of helping you stay within your chosen limit, away from unauthorised overdrafts. Simply: we don’t authorise payments that take you over your limit. You set your limit and we respect that. However, if mistakes happen and you do dip into the red, you’re not going to be hit with a penalty. We also won’t charge you for any payments that don’t go through. It doesn’t cost us, so why would it cost you?
But I heard overdrafts have a buffer zone. How much is that worth?
A buffer is an agreed amount which you can go overdrawn without paying interest or charges. At Starling, if your monthly overdraft interest comes to less than 10p for the month, we waive the entire overdraft interest. For example, say you take a £40 Uber that is paid via your overdraft. Even if you don’t pay it back until your well-deserved long weekend is over, Starling won’t charge you any overdraft interest.
Okay, so tell me about Starling's overdraft then.
At Starling, our aim is to increase financial awareness, especially when it comes to managing your everyday money. Fair interest rates, no fees and the ability to manage your overdraft all from your mobile online banking app are all part of our goal to give customers clarity and control over their money.
When you open an account with Starling, our team complete a few checks and determine an approved limit for your overdraft, which you can then accept for any amount up to that limit and begin using within your Starling app instantly, if you want to. This puts you in control of your limit and if you don’t want or need the limit Starling offers, no problem: just pick a lower one to suit you.
We believe a transparent, understandable and easy-to-use overdraft is central to creating the best current account, to helping people see their money more clearly, and developing a healthier financial life. This is why we offer a simple and transparent overdraft with a fair and consistent rate of interest of 15% EAR and why we don’t have any additional fees or charges. If you dip in without an agreement, we won’t hit you with penalties and you can control your overdraft limit all from within your digital banking app.