How Overdrafts have Become more Expensive than Short-Term Loans

Posted on 23rd August 2016

Overdrafts act like extra cash that you can borrow from the bank in case you need money. Not all bank accounts have overdraft facilities and maybe this is for the best. A new report by Which cited by the BBC found that getting an overdraft can be more expensive than a short-term loan. This is something that has been fascinating to discover because many consumers think that bank overdrafts are cheaper than short term loans found at consumer finance companies. It is important to compare overdrafts with the interest rates of short term credits and the benefits of short term loans to see why more consumers are seeing the benefits of consumer loans over traditional banking overdrafts.

What are overdrafts?

Overdrafts used to be a popular banking facility where if your account goes below zero, the bank essentially lends you ‘a safety net’ where you can still withdraw money even if you do not have money in your account. You will normally see a minus sign next to the amount that you have in your account. For example, if you have an overdraft of £1,000 and you are using it, you will see -£1,000 as the figure when you go to the cash point or when you print out your statement. Overdrafts used to be popular with students or businesses for example, because they essentially give you a flow of credit when you need it the most.

The rise of student overdrafts made many people think that they were interest free. This essentially meant that the bank had a certain amount of cash from which you could borrow and then you would not be charged any interest on top of that loan. This was like a free pot of cash for some people. However, these days, many overdrafts have high interest rates depending on how many days you are overdrawn on your account for. You need to read the small print of your overdraft agreement to know.

Some banks offer borrowers the chance to extend their overdraft without even going into the branch. This all depends on the costs and fees that will be connected to your overdraft. You need to know exactly how much an overdraft will cost you per day in order to make it worth your time.

How have overdrafts become expensive?

One of the most expensive fees for overdrafts is what is known as ‘daily fees’. Each bank will have its amount of what it will charge for overdrafts on a daily basis. If you are overdrawn on your account by 14 days, the bank will charge you at the end of the month and they will multiply the amount of days that you are overdrawn by. The more days that you are overdrawn, the more it will cost you in fees to the bank when it comes to repaying your overdrafts.

How are overdrafts used by borrowers?

Overdrafts have been used to help people with emergency money that is needed for any reason. Personal overdrafts have been used to help with monthly financial spending, while business overdrafts can help businesses pay for inventory. The rising costs of overdrafts have meant that it has become even more expensive for borrowers to use them personally due to the fees that are bundled at the end of the month with most overdrafts.

How can you compare overdrafts to short term loans?

Short term loans have energised consumer finance in the UK with millions of short term credit loans being taken out in the UK alone. Borrowers have been empowered to realise that banks are not the only institutions that can give them money when they need it as soon as possible.

Short term loans are more convenient

The beauty of consumer loans that are short term is that they are more convenient because they can be accessed instantly. Many responsible lenders still do credit checks and require you to have a job and fit other criteria – however you can still get a loan on the same day depending on the services of the lender and whether they allow it. Overdrafts still require different layers of approval at the bank and this can take a long time when you need the more straight away.

Short term loans are cheaper

Due to the fact there is a set date for repayments, short term loans are actually cheaper than overdrafts because the cost of the loan is bundled into the repayment schedule that you will have been set by your lender. Short term loans are also cheaper because they do not last for too long. Many loans can be repaid within a month. On the other hand, it could take a long time to repay an overdraft of £5,000 if you do not earn a significant amount or you do not have other income streams. Being stuck in an overdraft for several years will only cause you to feel like you cannot take control of your personal finances. With a short term loan, it is cheaper to borrow money and you are able to control when it ends because you can pay it off sooner.

Short term loans are not meant to be for the long term

One problem that overdrafts create for consumers is that in the long term, they keep you owing money to the bank for an indefinite period of time. For example, you could have an overdraft of £2,000 and you could have an indefinite time period to pay it off. For some borrowers this could make them less likely to repay the entire sum in full because the daily costs of the loan would not be seen as a big cost compared to a specific deadline upon which the entire loan needs to be repaid. Due to the fact that short term loans are not for the long haul, this makes them better for consumers because borrowers will take out the loan and then repay their debts at the same time.

How to manage emergency money spending

Overdrafts have become popular with borrowers as a way to access emergency money when it is needed. One way to manage your emergency finances better is to create an emergency fund that will cover any financial emergencies that you may get in your life.

Top tip 1: Open an account just for emergencies

You can open a bank account just to build an emergency cash pile. You should aim for at least 3 months of savings that amounts to your living expenses for 3 months. For example, if your salary at work is £1,500, you should aim to have £4,500 in an emergency fund that you can use in case you run into financial difficulty or you lose your job.

Top tip 2: Deposit money regularly into your emergency fund

You need to get into the rhythm of having an emergency fund that you need to pay for. One way that you can do this is by regularly depositing money into your emergency fund so that you can build the fund up every day. When an emergency happens, you will be able to use it.

Top tip 3: Use short term credit responsibly

The thought of building a 3 month emergency fund can be difficult and it can take several months to build an emergency fund that is equivalent to your lifestyle or the bare minimum. In the meantime, for emergencies, you could use high cost short term credit besides taking out an overdraft. The benefit of a short term credit over a banking overdraft is you will be able to pay it off faster than you would it you have an overdraft for a big sum of money. Overdrafts make consumers feel more comfortable but this can also cause you to overspend and therefore over borrow. Borrowers should opt for short term credit that can be accessed and paid off quickly so that debts are not hanging over their heads. Some overdraft facilities can cause people to be constantly repaying their overdrafts for years. If you want to take financial control over your life, you need to keep your borrowing to a minimum and ensure that you pay off your debts in a timely fashion.

Top tip 4: Learn how to budget

By learning how to budget effectively, you will be able to learn how to use short term loans to your advantage when it comes to emergencies. You should learn how to budget so that you can avoid using overdrafts because these can make your expenses spiral out of control. When you compare overdrafts with short term loans, you will see that using overdrafts all of the time can wreak havoc on your personal finances. Compare overdrafts with your current financial situation and see where do you want to be in the next year. If you take out an expensive overdraft that is for a big sum of money, you will find yourself still paying off the overdraft for many months or potentially years to come. Learning how to be better at spending your money, saving and becoming a better borrower is also important so that you can build a solid financial future for yourself.

Learn the power of borrowing with the right financial products such as short term loans. By choosing short term credit options, you will be able to solve your financial issues without being locked into a long agreement of making repayments.

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