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 simply fail. Some accounts allow a small overdraft buffer, for example £10 or £20, before overdraft fees are charged.
There are two types of bank overdraft. If your current account provider has previously agreed that you can go into debt, i.e. 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 usually charge different fees for arranged and unarranged overdrafts; arranged overdrafts generally result in smaller fees, or even none at all. That’s why you should always apply for an overdraft if you can, as unarranged overdraft charges can accumulate quite quickly.
For instance, if your provider charges you a fee of £5 per day for an unarranged overdraft and it takes you a week to pay off the debt, you would then owe your provider £35. Sometimes, this would happen even if you go just a few pence below zero.
This example also illustrates that in most cases it’s better to pick an account with an interest rate charge instead of a flat daily fee, with a 5% interest rate remaining cheaper than £5 until you go more than £100 into the red, even if both were calculated daily. And unlike most flat fees, interest rate charges tend to be calculated on a monthly basis, so you’d need to stay £100 in the red for seven months to owe your provider the same £35.
Of course, you’d rather not pay your provider anything at all and keep your money. That’s why it’s so important to consider the overdraft when choosing a current account, especially as some providers charge both interest and a fee.
✅ Overdrafts offer a safety net in case of emergencies and prevent bills and other important payments from falling through due to a lack of funds.
✅ As these accounts are specifically focused on offering you value for money when it comes to slipping into the red, they are likely to offer some sort of interest and/or fee-free overdraft buffers, which could save you a lot of money in overdraft charges.
❌ You don’t want to get too tempted to keep going into your overdraft, as this could have a negative effect on your credit score.
❌ You may miss out on account interest or other current account benefits that are not offered on overdraft accounts, but are available on high interest current accounts.