Overdrafts – What are they and how do they work?
Some bank accounts will allow you to keep spending money even if your balance drops past £0.00 – this is known as being overdrawn or using an overdraft.
Different accounts will have different stipulations regarding overdrafts – some will be interest-free, some will charge quite a lot and some won’t allow it at all.
Read on to find out more about the different kinds of overdraft on offer and about what to do if you find yourself relying on an overdraft to keep up with day to day expenses.
What is an overdraft?
An overdraft is a facility that allows you to spend more money than you actually have in your bank account. There are two basic types of overdraft that you should be aware of: authorised and unauthorised.
Authorised overdrafts are pre-arranged with the bank in question. You set an overdraft limit, the size of which can vary massively depending on the nature of the account. You are then allowed to go overdrawn by the amount decided without incurring severe penalties or fees.
An unauthorised overdraft is simply when you exceed the balance of your account without first arranging an authorised overdraft with your bank. Not all banks will allow this to happen but often, if, for example, a direct debit payment leaves your account when you don't have enough to fully cover it, you'll simply be entered into unauthorised overdraft. This will always incur heavy fees and so should be avoided at all costs.
Generally, banks will charge you for the use of an overdraft facility in the form of interest. Again, how high this interest rate is will be up to the bank, so if you want to find out how much you can borrow, and how much it will cost, then you should speak to your bank.
There are also various current accounts on the market that will offer interest-free overdraft facilities; you’ll just have to hunt around.
The vast majority of student accounts offer interest-free overdrafts with varying limits so if you’re at university you should talk to your current account provider and see what kind of facilities are on offer.
To find a current account with overdraft facilities with the lowest interest rates, head over to our comparison page. You can compare overdraft current accounts quickly, easily and for free with Money Expert.
When should I use an overdraft?
Overdrafts can be very helpful, particularly between pay cheques when you need a little bit of extra cash to help you along the way.
However, if you find yourself regularly using and relying on your overdraft, then depending on how much your bank is charging you for the privilege, you may want to consider another option.
Taking out a credit card or a personal loan might be cheaper and could leave you better off in the long run.
The important thing to remember about an overdraft is that it is not simply free money. You will have to pay it back and, depending on the interest rates or whether or not your overdraft is authorised, you could end up paying back rather a lot more than you spent.