Accounts with Overdrafts

Overdraft accounts explained

In simple terms, an overdraft is the debt you go into if you spend more than you have in your current account. The moment your current account goes into the red, you step into your overdraft - unless of course your bank account does not allow any overdraft, in which case your payment will be refused. You may even be charged a fee for the refused payment.

There are two types of bank overdraft. If your current account provider has previously agreed that you can go into an overdraft, you will go into an arranged overdraft. Going over an arranged overdraft, or going into debt where there is no arranged overdraft, on the other hand, is called an unarranged overdraft.

Providers can no longer charge higher rates of interest for unarranged overdrafts than they do for arranged overdrafts. Banks can also no longer charge flat fees for overdrafts, but only a single annual interest rate. This is to make overdrafts fairer for customers.

If you frequently find yourself dipping into the red, an account offering an interest -free overdraft would seem ideal. However, it's important to look at more than just the overdraft charges to find the right account for you.

Some accounts may charge a monthly fee, which could outweigh the benefits of low (or no) overdraft rates, while others may have additional benefits that could make up for having some overdraft costs attached.

What to look out for when comparing current account overdrafts will depend on your specific circumstances - particularly how often and how far you are likely to venture into your overdraft. For some, a small interest-free overdraft feature might be sufficient but for others, who are more likely to go into larger debt, will need to look at the overall interest rate charged on the account.

The EAR could be useful for comparing interest rates. It refers to the Equivalent Annual Rate, which looks at the interest you would be charged if you were to remain overdrawn for an entire year. It also compounds the interest, which is why it can look quite steep. All overdrafts must now also display an Annual Percentage Rate (APR) which has been a feature of credit cards and personal loans for many years. The APR has to take into account other account fees and is designed to allow customers to compare overdraft costs.

If you regularly find yourself in your overdraft and you're tired of paying high interest rates as a result, it may be time to switch to an account that offers a cheaper overdraft option. You will need a decent history of paying off your overdraft and other debts within a reasonable timeframe, however, otherwise providers may be reluctant to let you bank with them and use their credit facilities. If you have a bad credit score, a basic bank account or even a bad credit bank account (which does not require a credit check) might be a better fit for you.

For those with a decent credit score who would like to have low or no overdraft charges, even if they never intend to go into the red, there are some advantages and disadvantages to consider.

You can apply for a current account with overdraft as you do for any other current account, by talking to the provider you want to move to. If you're looking to switch your current account over entirely, the Current Account Switch Service should be a great help, as it automatically moves your direct debits and standing orders to your new provider, meaning you don't have to worry about missing payments.

Before you apply for anything, however, remember to check your credit rating. Your credit score at the time of application will greatly affect whether you get the account or not, so if there's anything you can do before applying to improve it, don't hesitate.

Also remember that changing your bank account will likely reduce your credit score slightly, due to the credit check that will be part of the application, so be sure of which account you're after before you apply and don't immediately apply for a different account if you get rejected.

All banks offering overdrafts must now have an online tool on their websites that will allow you to see if you are eligible for their account, before you apply. This allows you to see if it’s worth applying, but without any impact on your credit rating.