Our Guide to Managing and Reducing Your Overdraft Debt

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An overdraft is a short-term borrowing facility from your bank that allows you to spend more money than you have in your bank account. As soon as your bank balance drops below zero, you have gone into overdraft. 

Banks may charge fees and interest on your overdraft balance depending on how much you have spent and what kind of account you have. Interest charged on overdrafts tends to be higher than other forms of borrowing, such as credit cards and personal loans. 

There is no fixed term on overdraft debt, meaning there is no deadline by which you have to pay the money back.

However, it is repayable ‘on-demand’, which means that the bank has the right to take away your overdraft facility at any time and ask you to repay it in full. 

Did you know?
45-54-year-olds have the most overdraft debt, clocking in at £220 per person on average
Brits owed £6.4b in outstanding overdraft debt at the end of 2018/19
The higher your income, the more likely to are to hold an arranged overdraft 
In 2017, banks pocketed more than £2.7bn in overdraft fees alone. One-third of that came from un-arranged overdraft fees. 
Source: Financial Conduct Authority Annual Report 2018 and UKfinance.org

Overdraft Debt: Arranged v. Un-Arranged Overdrafts

When you open a new bank account, you may be given an option for an overdraft facility. This is an agreed limit up to which you can spend money, borrowed from the bank. When you use your overdraft, you’re in debt. 

Your bank will use your credit rating to determine your overdraft limit. This limit, agreed upon with the bank, is known as your ‘arranged overdraft’. Your agreed limit could be anywhere between £100 to several thousand pounds, depending on your bank, credit rating and needs. 

Many banks will allow you to enter into overdraft even if you have not agreed on a set limit with the bank. When this happens, you are going into ‘un-arranged overdraft’. Un-arranged overdrafts are normally capped at around £100. 

Going in to un-arranged overdraft can result in steep penalty fees, however this is soon about to change (you can read more on this below).

Overdraft Debt: Can I Switch Banks if I’m Overdrawn?

It is possible to switch banks even if you have an overdraft. In fact, this can be one way to escape high overdraft charges if your current lender’s fees are not very competitive. 

When you move banks with an overdraft, you take your overdraft with you to the new bank. This means you will need to make sure that your new bank is willing to give you an overdraft limit big enough to cover your existing debt. 

If you have a large overdraft (over £1000) you could struggle to find a new bank that’s willing to match it and may need to reduce your overdraft before making the switch.  

Overdraft Debt: Changes to Overdraft Charges

New regulations on overdrafts were due to come into effect in April 2020. Under these new rules, all overdrafts- whether arranged or un-arranged- will be subject to the same annual interest rate and banks will no longer be able to charge fees for going overdrawn.  

The Financial Conduct Authority (FCA) estimates that for 7 out of 10 people, their monthly payments will stay the same or go down. 

This especially applies for the 14 million people who use un-arranged overdrafts every year. 

Before, un-arranged overdrafts were often subject to disproportionately high fees and left the most stretched consumers feeling the sting whenever they overspent.  According to the Financial Conduct Authority, in 2017 more than half of UK banks’ income from arranged overdraft fees came from just 1.5% of customers- but that will change under the new rules. 

Due to a freeze on banking charges over Coronavirus, the new rules aren’t expected to come into effect until at least July 2020. 

The average annual interest rate for overdraft usage is set to hover at around 35%, although banks will be free to set their own- so you may want to shop around for the best deal.

Overdraft Debt: Does Having an Overdraft Affect My Credit Score?

Your credit score is influenced by how much of your overdraft you use and whether you pay your fees and interest on time.

When you apply for credit, lenders will look at something known as your ‘debt utilisation ratio’. This is a measure of how much credit you use out of the total available to you. 

If you are constantly living in your overdraft, you are utilising your available debt on a day-to-day basis. Lenders could take this as a sign that you are struggling to keep on top of your existing debts and think twice before offering you credit.

10 Ways to Clear Your Overdraft Debt for Good

1 – Budget

If you find yourself stuck in your overdraft and want to get out, you’ll first need to work out your monthly budget. To start paying off your debt, you want to make sure that your outgoings aren’t more than your income. 

You can then decide on a set amount you’ll dedicate to paying off your overdraft each month.

2 – Slowly Reduce Your Overdraft Limit

As you start to pay off your overdraft balance, it is a good idea to slowly reduce your limit. This ensures that you won’t be able to easily slide back into more debt and undo your hard work. 

Many banks now allow you to reduce your limit on your mobile app or online. Whether you can do this at home or need to visit your branch, try and make a monthly habit of reducing your limit, even if it’s just a little. Reducing your limit by just £10/month would see the end of a £500 overdraft within a year.

3 – Switch Bank Accounts

If your overdraft fees are eating into your budget and stopping you from paying off your overdraft, consider switching to a bank with a lower interest rate or interest-free overdraft.

Some banks offer up to £250 interest-free. With the money you save by switching, you could start chipping away at your overdraft debt.

4 – 0% Money Transfer Credit Card

If you have a large overdraft and reasonable credit score, you could consider taking out a 0% money transfer card. This is a type of credit card which allows you to clear your overdraft by transferring cash into your account. You’ll have a limited time (normally 18-24 months) where your debt is  interest-free.

This can be a great way to save money on fees and separate your debt repayments from your daily spending. Just remember to cancel your overdraft once you’ve paid off the balance with your credit card, so you’re not tempted to dip into it again. 

5 – Prioritise Your Debts

Feel like you’re drowning in overdraft debt? It’s possible to hold overdrafts on multiple bank accounts, not to mention credit cards, personal loans and all manner of other financial products. 

With all that debt in so many different places, it’s easy to feel overwhelmed. Coming up with a clear strategy can help.  Compare the fees on your overdrafts and other debts and rank them from least-most expensive. Once you’ve done this, there are two approaches you can take: 

Avalanche

Keep paying the interest and charges on all of your overdrafts and credit. Put any extra money towards paying off your largest, most expensive overdraft first.

Once you have paid this off, use the money you were putting towards this to chip away at the next most expensive debt. It can take a while to see results with this method, but by dealing with the most costly debts first, you’ll save money in the long run. 

Snowball

This is the opposite of the avalanche. Keep paying your interest and account charges on all of your overdrafts and put any extra money towards clearing the least expensive account first.

Once you have paid this off, put that money towards clearing the next most expensive debt, and so on, until your overdrafts are all cleared. You will see results quickly with this method, which can help to keep you motivated.

6 – Treat Your Overdraft Like a Loan

One feature of overdrafts which can make them difficult to manage is the lack of separation between your daily spending and your debt. To simplify matters, consider opening a basic bank account (with no overdraft facility) and using this for your day-to-day spending. 

Whenever you’re paid, transfer enough money to cover your essentials to the basic bank account. Leave as much as you can afford in the overdraft, as a deposit on the debt. This way, you will avoid accidentally overspending and falling back into debt, as you gradually pay off your overdraft.

7 – Save Up to Pay It Off

If you already have savings, you might consider using them to pay off your overdraft. If you don’t have savings yet, you could consider saving up to pay off your overdraft in one lump sum.

This method ensures your repayments don’t get swallowed up by your day-to-day spending, and is relatively simple to set up and keep track of. However, you will have to keep paying interest fees on your overdraft until you have saved up enough to pay it off.

8 – Low Rate Personal Loan

Taking out a personal loan to clear your overdraft could be cheaper in the long-run than paying interest on your overdraft debt. However, you will need a reasonably good credit score to be eligible for a loan with good enough interest rates to make this worthwhile.

It is also important to cancel your overdraft facility once you have used the loan to pay it off, to remove any temptation to use it again. 

9 – Speak to Your Bank

Under Financial Conduct Authority (FCA) rules, your bank is obliged to treat you fairly if you are suffering from financial hardship. If you find yourself penalised with high fees for going over your agreed limit, it may be worth speaking to your bank.

They may be able to waive penalty fees or offer you a less expensive borrowing option. If you believe your bank is treating you unfairly, you can also tell the UK’s Financial Ombudsman

10 – Get Support

If you’re still struggling with overdraft and debt, try speaking to a debt counselling service. Debt advisors will be able to listen to you, assess your situation and help you forge a path forwards out of the debt cycle. 

How Can Love Debt Free Help?

Here at Love Debt Free, we have partnered with some of the UK’s leading Debt help companies.

They have already helped thousands of people reduce and manage their debts, and they can do the same for you.

Choosing an independent adviser means they won’t recommend a scheme unless they are sure it is in your best interests. Their advice is also regulated by the FCA, which gives you an additional layer of protection.

If you would like to speak to one of these debt help companies, click on the below and answer the questions.

Len Burgess
Len Burgess
Len Burgess is a successful digital entrepreneur and founder of LBLK Publishing which specialises in Financial content. Len has been writing professionally on financial and business topics for 5 years before starting Love Debt Free.
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