Overdrafts can be a very hard form of debt to pay off. But even authorised overdrafts aren’t cheap (once you stop being a student) and unauthorised overdrafts are very expensive. Which? found in 2017 that if you use unauthorised overdrafts a lot they can be more expensive than payday loans!
Very hard to escape from
Overdrafts aren’t the worst kind of debt. They aren’t as bad as Amigo loans or logbook loans. But they are a big problem for many people. In 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.
And they can feel impossible to escape from.
The gerbil on this wheel is enjoying going round and round and never getting anywhere. For many people, their overdraft feels like this, but without the enjoyment!
You get paid and your overdraft drops nicely – perhaps you even get back into the black for a few days. But then the bills start being paid and your account sinks deeper and deeper into the red. And the bank takes its monthly charges out to make things worse.
Are overdrafts going to get cheaper?
In July 2017, Lloyds announced it was simplifying charges for Lloyds, Halifax and Bank of Scotland overdrafts. Nine out of ten people will pay less, but people who regularly use a lot of their overdraft may end up paying more. See Lloyds overdraft changes – the winners and losers for details.
Other banks may follow Lloyds lead. This may help you but it’s not safe to rely on it.
Very temporary overdrafts are great!
If you don’t use your overdraft regularly, an authorised overdraft is very convenient. A delay of a couple of days in being paid, a big bill just before you get paid… in this situations an authorised overdraft saves a lot of trouble and as you are only in it for a few days, it doesn’t cost much.
This is what overdrafts were originally designed for. But over the years they have changed into a permanent debt for many people.
“It didn’t feel like a real debt”
Many people don’t even think of their overdraft as a real debt until they go over their limit
This may be because you don’t have to pay any money to it each month like you do a loan or a credit card. So it doesn’t feel like money you have borrowed that has to be repaid.
Some banks describe the amount you are under your limit as funds available. That makes it sound like it’s money just there for you to spend, not a debt that is growing bigger if you do.
So using your overdraft becomes a habit, not something you worry about at all until you get close to the limit. And then you may find your bank increases your limit!
Most students end their uni courses with a large overdraft. That never felt like a real debt because it was free!
But this is a real debt :(
Here is what’s bad about living in your overdraft:
- the bank charges are often high, even for authorised overdrafts;
- other lenders will think of your overdraft as being “real debt” if you apply for a mortgage or other credit;
- if you are routinely using a lot of your overdraft every month, you don’t have it there as a back up for an unusual situation. That means an unauthorised overdraft, with its very high charges and a black mark on your credit record.
Why is this so hard to pay off?
A loan is simple – you pay so much per month and the amount owed keeps falling.
Credit cards are a bit harder as you are always tempted to use the card again. But you can leave it at home, put it in the freezer in a block of water, give it to your partner to look after or even cut it up … if you are determined you can keep a credit card balance going down each month.
But you can’t stop using your current account. And there isn’t a way of automating reducing your overdraft by setting up a regular payment.
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 either.
So it’s psychologically much harder to reduce or clear an overdraft if you are still using the account.
Aim to reduce it every month?
Many people hope to sort out their overdraft by reducing it by a bit each month. If you want to try this, four things may help.
- having a really good budget which you check before you spend money, not after. So you use it to make decisions not just keep score.
- making sure your partner is completely onside. You both have to be very determined to make this work.
- try to kick-start the process by having a “no spend” month or two: no new clothes, eat up the contents of the freezer, no takeaways, 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.
- have a general “money detox” which gives all your finances a boost and may remove some of the direct debts and standing orders that you are currently paying.
But for many people this “chipping away at it” approach simply doesn’t work for month after month.
Get a new bank account
This is often the most practical alternative. Sometimes you can transfer your overdraft to a new account, especially if your credit rating is good and the overdraft isn’t large but you don’t want to do this – it’s better to start by thinking of your new account as one where you are going to be in the black for all except a few days each year. So just switch to using the new account and cancel all direct debits and standing orders on the old account. Then you can repay the old overdraft a lump at a time. Make sure you pay in at least as much as the bank charges and it’s will start dropping every month.
Find out more about this and other ways to convert your overdraft to something you can repay in monthly installments.
Tackle your other debts first
If you have tried chipping away at it and got nowhere and you don’t want to change bank accounts, you could decide to live with accept the high overdraft charges and get on with dealing with your other debts. If you can pay off a credit card or a loan, your general situation will improve and you are more likely to succeed in another go at your overdraft. It has to go at some point!
Is your overdraft just part of a big debt problem?
If your financial situation is so bad that you can’t see how you are going to reduce any of your debts, 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.