In May 2016, the Competition and Markets Authority said banks should cap overdraft charges and warn customers if they are about to go overdrawn – but “should” isn’t the same as “must”, so if you have an overdraft problem, you can’t rely on that helping you in the near future!
Overdrafts are an increasingly bigproblem for many people. In January 2016 a survey found that the average amount owed on overdrafts had gone up by almost two-fifths from £870 to £1,190 over the previous six months.
Overdrafts aren’t the worst kind of debt. They aren’t as bad as Amigo loans or logbook loans, and if you don’t have a debt problem at all, an overdraft can be useful… But the interest and charges on unauthorised overdrafts can be horrendous – in some cases worse than payday loans as Which? reported in July 2016. And even if you stay within your overdraft limit, they can feel impossible to escape from.
The gerbil on this wheel is enjoying going round and round and never getting anywhere – but if you are fed up with getting paid then watching your bank balance slip deep into the red every month and paying overdraft charges, what can you do?
How much are you paying for your overdraft?
The first thing is to find out exactly what you are being charged at the moment. This will be some combination of interest charges, maintenance fees, usage fees, paid and unpaid items fees and unauthorised overdraft fees. That all sounds complicated and it can be – the FCA (the banks’ regulator says banks make money from “consumers’ lack of understanding, confusion and limited attention”. So if you want to stop your bank making large profits from you, you have to find out the details.
You need to know just how your overdraft charge last month was calculated, and how it might change if your overdraft was lower. For example Barclays has “tiered” charges, charging you 75p , £1.50 or £3 a day for each day your overdraft is less than £1,000, less than £2,000 or over £2,000 respectively. So roughly how many days a month do you use your overdraft? Do you ever have charges because your bank has refused to pay a direct debt or standing order? Do you ever exceed your overdraft limit?
Once you know what “the damage” is, you are in a better position to assess which of the following alternatives would suit you best.
1) Clear the overdraft!
There are basically three ways to do this:
- use your savings to pay it off It is foolish to have cash in a savings account or ISA or premium bonds, paying very little interest, when you are paying a hefty amount for an overdraft every month. You may think it’s good to have the savings “for an emergency”, but if you clear your overdraft, then that can be there for an emergency.
- get a cheap loan This is only worth it if the loan is quite a lot cheaper than the overdraft, otherwise you have just increased your debt problem.
- get a 0% purchase credit card 0% balance transfers won’t usually let you move the money to your bank account, but if you get a “0% on new purchases for x months” card, and use that for all your groceries, petrol etc for a few months instead of paying cash from your bank account, then bit by bit you are effectively transferring the debt from your overdraft to the new card. Of course you may then end up with credit card debt that costs more than your overdraft unless you then go onto clear the debt before the 0% period ends.
These approaches all have two big snags. First you have to have enough savings or a good credit record to go for one of them. Secondly, they all run the risk that once you have cleared your overdraft, it will then just drift up over time. You are going to have to be seriously determined to not let this happen. Are you?
2) Change banks
You can change bank accounts if you are overdrawn, but the new bank doesn’t have to give you an overdraft. If you have a good credit record you may be able to get one of the Best buys if you are overdrawn accounts with an overdraft which charges less than your current one does. A bank transfer from your new account to the old one will then pay off the overdraft. Then close the old account – if you don’t then it’s just temptation sitting there, waiting to be dipped into again.
If your new bank won’t give you an overdraft, or only a small one, then you can still switch accounts and leave your old overdraft as just another debt to be paid off. Move all your income, benefits, direct debits and standing order over to the new account (this is a good time to review these – do you really need all of them?) and set up a standing order from your new account for the amount you want to pay off the old overdraft each month. Providing this is more than the interest/usage charges, the balance will go down steadily and, importantly, you won’t get hit with extra charges for unpaid items or get any deeper into debt.
If the overdraft itself has created much of your debt problem or made it worse, you need to change banks to prevent it getting worse. Also read MoneySavingExpert’s guide to reclaiming overdraft charges and see if you fit into one of the categories of people that can get the charges refunded.
3) Aim to reduce it every month
You may find this very hard to do if you are still using the account. There isn’t a way of automating reducing your overdraft by setting up a regular payment.
It’s psychologically much easier to handle credit card debt as you can just stop using the card – leave it at home, or even cut it up. But you can’t stop using your current account. And with all the complicated transactions on your current account – pay going in once a month, possibly variable amounts if you don’t work fixed hours, tax credits going in at different times, rent/mortgage and bills all going out on different days by direct debits etc – it’s not always simple to see what is happening.
A really good budget which you monitor before you spend money, not after, would help. Another useful approach is to have a couple of month where you aim to spend as little as possible – nothing on clothes, eat up the contents of the freezer, not going out, have a car boot sale to raise some cash etc. This isn’t a good way to tackle a long-term debt problem (see How far should I cut back?) but it can get you off to a good start.
If you are serious about paying off your overdraft, a good bank to switch to is Nationwide, where you get a fee free overdraft for the first 12 months – but the penalty for exceeding your overdraft is high, so keep a close eye on it! I like their first-time fee refund promise: “We can all slip up sometimes and lose track of our outgoings. So the first time you let us know you’ve made a mistake, we’ll refund any overdraft fees you’ve incurred.”
4) Pay everything as late as possible
If you can move some large payments to be just before your payday, then in theory you maximise the amount of money in your account during the month and so your overdraft charges should be less. The problem with this option is that it is the exact opposite of “easy budgeting”, where it is usually suggested that you pay the essentials – rent/mortgage, council tax, bills etc – straight after payday so that you know how much money there is left over for everything else. You may find yourself spending too much on other things early in the month with all that money sitting in your account so you may go over budget and even have some important payments at the end of the month rejected by your bank :(
If you want to try this you have to be really serious about budgeting.
5) Tackle your other debts first
If you don’t think any of the first four alternatives will work, then another option is to accept the high overdraft cost and get on with dealing with your other debts. You only have a limited amount of time and energy – it may be better to use that to improve your budgeting, change your utility suppliers, start meal planning etc rather than change your bank accounts.
If your debt repayments are going well and budgeting is becoming second-nature, then you can revisit the overdraft problem in six months or a year and see if you feel more confident about picking one of the other options. That overdraft has to go at some point!
6) Handle your much bigger overall debt problem
If your financial situation is so bad that you can’t see how you are going to reduce any of your debts, then you need to look at the bigger problem. This usually means getting a new bank account and then the overdraft on the old one becomes another debt in your Debt Management Plan or gets included in whichever of the insolvency options you choose. See What are my Debt Options? for a simple guide to the alternatives.
If the overdraft itself has created much of your debt problem or made it worse, read MoneySavingExpert’s guide to reclaiming overdraft charges.