An overdraft is a short-term way to borrow money on your current account and can be a lifesaver on occasion, but start relying on your overdraft and you can end up in some serious debt due to high interest rates and unarranged overdraft fees.
An estimated 7.3 million people in the UK use both an arranged overdraft and unarranged overdraft each year, with more than 2 million getting stuck in a permanent ‘vicious cycle’ of overdraft debt – while one in five (20%) young people go into their overdraft every month just to make ends meet.
This year the Financial Conduct Authority (FCA), the UK’s financial regulator, announced that it would be shaking up bank overdraft fees by stopping banks overcharging for unplanned overdrafts. The new rules, which were announced in July and come into effect in April 2020, will stop banks and building societies from charging fixed daily or monthly fees for overdrafts and they will instead be required to charge a simple annual interest rate on all overdrafts.
The FCA said that banks made more than £2.4bn from overdrafts in 2017, with 30% coming from unarranged overdrafts.
One in five (20%) young people go into their overdraft just to make ends meet.
Debt charity StepChange welcomed the FCA’s new rules and said it hopes it disrupts the toxic ‘debt spiral’.
Sue Anderson, Head of Media at StepChange, told Refinery29: “The FCA’s new rules on overdraft charges should help to disrupt the toxic ‘debt spiral’ effect that repeated use of unarranged overdrafts can create. Requiring firms to intervene earlier and more meaningfully when their customers show repeated use of overdrafts is hugely important, too.
“In a survey of our clients last year, we found that nearly four in five (79%) who used an overdraft were constantly overdrawn in the year before they sought help from us. Clearly more work is needed to establish how to reduce reliance on overdrafts in practice, and to understand the link between persistent overdraft use and problem debt.”
Since the FCA’s announcement, some banks have adopted new rules ahead of the April 2020 deadline.
HSBC announced on Thursday that it would be removing its £5 daily fee for going into an unarranged overdraft and introducing an interest-free buffer of £25 on some accounts. It is also introducing a single overdraft rate of 39.9%.
The FCA said banks made more than £2.4bn from overdrafts in 2017 alone.
The new single rate for all overdrafts matches the 40% rate announced by Nationwide in July, but it has drawn widespread criticism as around 8 million HSBC customers will see their overdraft rate doubled, and some quadrupled. It is the second and biggest UK bank to react to the FCA’s new rules.
Banks such as Barclays, Lloyds Banking Group and the Royal Bank of Scotland are still charging daily fees for arranged overdrafts on certain accounts. However, they all offer interest-free arranged overdraft limits for student accounts.
An arranged overdraft is a set amount you can borrow which you’ve agreed with your bank. There are no charges for this but you do pay interest on the amount you are overdrawn. If you enter an unarranged overdraft, you will pay a fee (for example Barclays charges £5 per day) and interest on whatever you go overdrawn by.
Overdrafts can be a good short-term option for some people, but they are not recommended for long-term use because they can be overwhelming, especially if you are struggling to meet the daily or monthly fee, or you are short of cash.
However, different current accounts have varying overdraft fees and charges so it’s important to check this before you arrange one with your bank.
Here are some tips from StepChange to help you get out of the red and into the black.
Create a budget
Making a list of your income and expenditure can have a huge effect on your finances. You can’t be in control of your finances without understanding what you have coming in and where your money is going (we’ve got some great tips on creating a budget).
Once you’ve got a budget you’ll know what you need for your bills, living costs and debt repayments. This should tell you if you’ve got enough money available every month to repay your overdraft. It can help you plan your spending so you’re less likely to be as overdrawn.
Talk to your bank
Many people are wary of contacting their bank to tell them they’re struggling, but it’s a good option.
Most banks will let you contact them via phone, email, web chat or in person. However you get in touch, you can explain that you’re worried about always being overdrawn and you’d like to reduce your overdraft. Ask them to help you.
The response you receive will depend on your bank, but if you’ve got a budget worked out then you’ll better understand what you can suggest as an affordable repayment. You could ask them to bring down your overdraft limit every month by an amount you can afford and then you’ll steadily clear the debt.
Separate your overdraft from your day-to-day banking
Trying to pay off an overdraft while you’re still using it every month is like trying to bail out a ship while it’s still taking on water. It’s much easier to repay an overdraft when you no longer use it to cover your living costs.
When you talk to your bank about dealing with your overdraft they may suggest a way you can separate your overdraft debt from your day-to-day banking, such as helping you open a new account with them. This means you can break the cycle of dipping in and out of your overdraft all the time. It makes it easier to keep your finances organised and to treat the overdraft like any other debt.
If your bank isn’t able to separate your overdraft debt from your main bank account then it may be worth opening a new bank account with no overdraft, with a bank with which you have no debts. This new account can be used for your income and managing your day-to-day money. Your old bank account remains overdrawn, but you can then treat it like a regular debt and it’s untangled from the rest of your finances.
Chip away at your overdraft balance
This is the hardest bit. Making a plan is easy compared to sticking to it in the real world. This will involve following your budget carefully and making your payments each month.
While unexpected events may pop up, having a budget will help you prepare for these. When you see your balance reducing it should help to keep you motivated.
If you are worried about debt, contact StepChange’s hotline for free advice on 0800 138 1111 or visit the website at www.stepchange.org.
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