More than 2 million people in the UK have overdrafts, stuck in a cycle of using their overdrafts to survive the month, paying off the overdraft from their salary only to begin using it again.
The Financial Conduct Authority (FCA) found that nearly 13 million people in the last 12 months had used an overdraft facility. Most people use overdrafts merely to make ends meet with:
- The average overdraft debt is £1,722
- 79% using overdrafts to pay household expenses
- 57% using their overdrafts to pay for food and groceries
- 27% using overdrafts to pay their monthly bills
According to Peter Tutton, Head of Policy at debt charity:
“Many of our clients, among whom overdrafts are the second most common form of debt, are trapped in a monthly cycle of overdraft debt just to make ends meet. The level of charges incurred can simply serve to deepen existing financial problems.”
Overdrafts can provide a convenient way for borrowers to stabilise their finances at borrowing rates lower than personal loans. However, this is referring to arranged overdrafts; unarranged overdrafts can impact consumers with crippling borrowing rates.
Types of Overdrafts
According to the Money Advice Service Arranged or Authorised Overdrafts must be arranged in advance, where you agree on a borrowing limit with your bank – allowing you to go overdrawn. Typically, with a lower interest rate, you can spend your overdraft by your usual methods without fear of additional charges.
An Unauthorised, Unplanned or Unarranged Overdraft is when you spend more in your bank account without agreeing with the bank first to do so. This also includes if you happen to “go over your overdraft” (borrowing more than your current agreed overdraft limit).
In addition to daily interest applied – banks will also apply a fee. It is these fees and interest that become crippling for unarranged overdraft users.
How expensive are Overdrafts?
With Payday loan charges being capped since January 2015 to £22.40 on £100 borrowed, consumer group Which? found that high street banks were charging up to £90 on the same amount for an unarranged overdraft:
- RBS allows customers a £10 buffer and then charges £6 a day up to a maximum of £90 in any 30-day period.
- TSB, Lloyds and HSBC all charge up to £80.
- Some customers at Halifax pay £5 a day, up to a maximum of £100.
Alex Neill, director of policy and campaigns at Which?, said:
“People with a shortfall in their finances can face much higher charges from some of the big high street banks than they would from payday loan companies.”
Alarmingly, it is not only unauthorised overdrafts that will hit you hard, now, the banks have raised the fees for authorised overdrafts!
Lloyds and Halifax of the Lloyds Banking Group used to charge 19.98% annually for an authorised overdraft rate. Now, it’s been raised to 52% if you borrow £500 over seven days.
By introducing a new charging structure of 1p a day for every £7 borrowed, arranged overdrafts are no longer a cheaper solution that they used to be, when compared with Payday loans and unarranged overdrafts.
In a recent study published on the BBC website, Which? compared the cost of borrowing £100 for 30 days across 16 high street banks and found that 13 of the banks charged more than a payday loan lender – with some of the banks charging a lot more!
Overall, Which? found that unarranged overdraft fees can cost borrowers up to 7x more than a payday loan!
5 things you should never use an overdraft for
Authorised overdrafts can be a valuable resource when you need a temporary supply of cash to support your outgoing expenses. Yet, there are unquestionably situations where you should never, ever, apply for an overdraft, authorised or not:
1. Fund your upcoming holiday
Whether paying for your next annual holiday or adopting an overdraft for “your spending money” – needless to say, this is not a great idea. OK, you’ll remove the stress and worry of having to save for the holiday and how much you can spend whilst abroad.
Upon your return, you’ll have debt that will take you until your next holiday to pay back. If you went overdrawn into an unarranged overdraft, the fees would be even worse. You’ll be taking on several months of financial worries for one stress-free holiday. Is it worth it?
2. Paying back Family and Friends
Borrowing money from your parents and friends is not ideal and is often combined with the embarrassment of having to admit “you’re a bit financially short” or worse, that you cannot manage your finances.
Wanting to pay them off, restoring your pride is understandable, yet getting an overdraft to achieve this will cost you more in the long-term, and may even require you asking them to lend you even more money due to the cost of the overdraft fees.
Explain to them your status quo, and advise how you are going to pay them a little each month.
3. Investing in your business
Using any form of borrowing to invest into your business is a risky strategy, and businesses do not always work out. Obtaining a loan against a business means that should the business fail, the loan goes with it.
Thus, borrowing money from your overdraft to invest in your business is a no-no. If your firm folds, then you’ll still be saddled with crippling personal overdraft interest and fees that you’ll be liable for, and have to pay back, but without proceeds from your recent business venture.
Even if you believe that you’ll repay your overdraft with proceeds from the business, more often than not this never happens – so don’t do it!
4. Buying gifts and items you usually cannot afford
Research from Peachy has found that most people would spend above their means to satisfy their loved ones. With Valentine’s Day, Birthdays and Christmas being the serial offenders.
Dipping into an overdraft, either authorised or not, means that although you shower your family and partners with gifts when it matters most to them, it will cost you more the initial gift price.
Friends and family will understand, and they certainly would not want you to get into debt on their behalf.
5. Paying off a loan
Paying off higher interest earning debt is always a sound strategy, yet as this article has pointed out, paying off a payday loan or personal loan with an overdraft is anything but.
With increasing interest rates and overdraft fees, the amount you borrow from an overdraft to pay off your loans may be more than the loan’s interest itself! Payday loans themselves have interest charges capped, overdrafts do not, so be aware and do not fall into this trap.
If used sensibly, and for emergencies only, overdrafts (much like payday loans), can be a temporary measure to sort out a financial mishap or unexpected expenses.
However, they should never be considered a long-term option – especially considering the uncapped charges that are increasingly applied by the high street banks.
So, think long and hard about the next time you want to take out an overdraft. Otherwise, your financial solution could quickly turn into a long-term cycle of debt and stress.