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How does a current account overdraft work?

Category: Banking
Author: Tim Leonard
Updated: 12/03/2018

How do you use your current account? Do you regularly have to dip into your overdraft?

Overdrafts are a form of borrowing from your bank or building society, and they can be expensive, so it's important to compare the EAR interest rate as well as any charges when you choose a current account.

Overdraft buffers

Some banks and building societies will offer a small interest-free buffer zone if you become overdrawn by a few pounds.

If you think you are going to become overdrawn, contact your bank to find out if you'll go beyond your interest-free buffer and see if you can get a temporary overdraft to avoid any charges.

Authorised and unauthorised overdrafts

There are two types of overdraft: authorised and unauthorised.

  • Authorised overdrafts are pre-agreed and allow you to go overdrawn (or borrow) up to a certain limit, normally at a set rate of interest. The way overdrafts are charged is changing: some banks may charge a monthly or a daily usage fee, which may be instead of interest or in addition to interest.
  • Unauthorised overdrafts are not pre-agreed. This may be because you don't have an authorised overdraft at all, or you have gone over your authorised overdraft limit. The bank or building society may honour your payments, although they will probably charge you a fee for doing so and potentially additional daily fees as well. Interest rates for unauthorised overdrafts can be much higher than for authorised overdrafts (up to 30%!), so they're a very expensive form of borrowing. If you know you're going to creep into an unauthorised overdraft, try contacting your bank in advance to see if you can arrange a temporary authorised overdraft instead.

Is an overdraft current account right for you?

If you tend to use an overdraft each month, it's better to have a pre-agreed authorised overdraft. Even pre-agreed overdrafts can be expensive, so you should only rely on your overdraft for cashflow between paydays, not for longer-term borrowing.

If you find your overdraft balance creeping up or staying the same, month after month, take action and read this guide to repaying your overdraft.

However, if you use your overdraft sparingly and pay it off within a couple of months, make sure your current account is competitive by checking out our selection of the best overdraft current accounts.

Alternatives to overdrafts

If you dip into your overdraft because of occasional retail spending, consider using your credit card instead.

You get an interest-free grace period of up to two months on a credit card (which you don't get from an overdraft) plus the added benefit of purchase protection. Just be sure to clear the balance in full at the end of the month or this option could become more expensive

Payday loans should be considered a real last resort as they charge annual rates of interest that often exceed 1000% APR! If you really need to borrow a small amount of money quickly, make sure you check with your bank to increase your overdraft or contact your credit card provider to up your credit limit.

What next?

Find the best bank account for you - compare bank accounts.

Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.