Overdraft bank accounts sound like a great idea, but are they a risk you don’t need? We look into what they are
You can use an overdraft to borrow money from your bank, if you’re running low before pay day or you’ve got an unexpected expense, for example.
But while it’s there for you to use, overdrafts are often the most expensive way to borrow, with higher interest rates than over forms of borrowing.
We explain here how overdrafts work and how much they cost to help you work out if you should use one.
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What is an overdraft bank account?
An overdraft bank account is a current account that has an overdraft attached to it. These accounts work exactly the same way as accounts without an overdraft, but provide a little extra buffer for you to use if you need to.
If your bank account has an overdraft, this is money you can borrow each month. There will be a limit on this money and often an interest rate, so you are paying to borrow the money.
To get an overdraft your bank will need to look at your financial history and also details like your income. This is so it can assess the risk of giving you this money, and work out if you can comfortably afford to repay it if needed.
A hard credit check (which remains on your credit report) is carried out when you apply for an overdraft. Using a free eligibility checker, to check your chances of being approved, won’t impact your credit score as these tools only use soft searches.
Are there different types of overdraft bank accounts?
There are two main types of overdraft that you can get with a UK bank account, if you’re eligible. Both of these usually have interest charges which you will pay if you use them.
Arranged overdraft bank accounts
An arranged overdraft has been agreed by your bank. It is a limit, such as £1,000, that you can use if you need to. This money shouldn’t be seen as a long-term borrowing option but more as an emergency pot if you have an unexpected bill.
Unarranged overdraft bank accounts
An unarranged overdraft is when you spend more money than you have. It is money you are borrowing that hasn’t been agreed by your bank or it’s money you are borrowing if you have used your arranged overdraft.
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Do UK banks offer a guaranteed bank account with overdraft?
No, banks in the UK don’t always guarantee you will have an overdraft. You can open a bank account with an overdraft or sometimes you can open a bank account and request an overdraft at a later date.
However, overdrafts are a form of borrowing and you will need to meet eligibility requirements from your bank to be able to get one. These includes the bank checking your credit history and looking at things like your regular income to make sure you can comfortably afford to repay the overdraft.
What costs can overdraft bank accounts incur?
If you use your current account overdraft, you will probably pay interest (unless it’s a 0% interest overdraft). This is a set rate of interest that is charged on the amount you use.
Previously banks were able to pay a higher amount of interest on unarranged overdrafts and charge fees if people used them. But since April 2020 they are no longer allowed to do this. The interest rate you pay when you use your overdraft will be the same if it’s an arranged or unarranged overdraft.
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Do overdraft bank accounts affect your credit score?
Using an overdraft can impact your credit score in several different ways:
Using your unarranged overdraft can harm your credit score as this is an amount of money that has not been agreed by your bank. Using it indicates that you are not managing your money well and it can also lead to payments failing which can harm your credit score too.
Applying for an overdraft will require the bank to run a hard credit check. This remains on your credit report for up to two years, but it’s only likely to harm your credit score if you’ve made lots of credit applications in a short space of time.
Using an arranged overdraft occasionally, staying within the limit and paying it back can show you are using this money responsibly and could boost your credit score.
Constantly maxing out your arranged overdraft increases the amount of money you’re borrowing. This impacts your credit utilisation score – which is the amount of available credit available you are using. This can harm your credit score as it indicates you are consistently relying on this money.
Which banks offer overdraft accounts?
Lots of banks offer overdraft accounts, and if you believe an overdraft would be useful (and you can repay it regularly) you have lots of options.
If you only need a very small interest rate there are a few accounts offering 0% interest.
At First Direct, for example, there is a £250 0% overdraft but this rises to an effective annual rate (EAR) of 39.9% if you borrow more. The TSB Spend & Save Plus account offers the same amount (and fee for going over £250) although this is a paid-for monthly account.
However, if you want a bigger buffer there are accounts offering a higher overdraft for an overall lower interest rate.
Starling Bank, for example, offers an overdraft of up to £5,000 at a rate of 15%, 25% or 35%. At Monzo Bank the overdraft limit is lower, at £3,000 with rates of 19%, 29% or 39% depending on your credit worthiness. You’ll be told the rate before a hard credit check is made.
We list all of the best current accounts with overdrafts here.
What should I look out for when taking out an overdraft account?
If you want an overdraft, it’s important to consider the following before choosing an account and applying:
- Is it the best option? Overdrafts are just one way to borrow money so always compare the costs with other deals including personal loans and credit cards.
- What is the interest rate? There should be one interest rate charged on anything you borrow in your overdraft. These vary considerably and often there may be a small amount you can borrow for 0% interest which quickly jumps up if you go over this limit.
- How much can I borrow? Do you want a small buffer to dip into occasionally or would you prefer a larger limit. There are different accounts for both options, and your overdraft limit will also depend on your own credit history and the lender’s eligibility requirements.
- Are there any extra perks? If you’re opening a new current account with an overdraft, after you’ve checked the rates on offer remember to look at what else the account includes.There may be a cashback offer, for example, or extra benefits such as insurance thrown in. While these can be great if you use them (and they are cheaper than taking them out separately), they shouldn’t be the only reason to open a new account.
