Do you worry you will always be stuck in your overdraft?
You aren’t alone. Overdrafts can be the hardest sort of debt to pay off. Even authorised overdrafts aren’t cheap, once you stop being a student.
So what can you do that will work?
Very hard to escape from
The hamster on this wheel is enjoying going round and round and never getting anywhere. For many people, their overdraft feels like this… but without the fun.
You get paid and your overdraft drops nicely – perhaps you are 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, making things worse.
Very temporary overdrafts are great!
If you don’t use your overdraft regularly, an overdraft can be very convenient. A delay of a couple of days in being paid, a big bill just before you get paid… in this situations an 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 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.
Using your overdraft can easily become 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. And here is what’s bad about living in your overdraft:
- the charges are often very high;
- it’s depressing. Your work and life become one endless round of payments and income that is never quite enough;
- 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.
Many people are now being charged more for overdrafts
In 2019, the FCA announced big changes to overdraft pricing, making them much simpler. The FCA hoped this would bring the charges down.
But when the new fees came in 2020, there were some winners but a lot of big losers:
- people who used an unauthorised overdraft have seen the charges reduce as banks aren’t allowed to charge more for them now;
- flat fee charges such as £10 a month or £3 a day are now banned, so people that use their overdraft very little have normally done well
- but 8 million people who used their overdraft regularly are the losers, seeing their interest charges go up much more than the gains from losing the flat fees.
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 easily 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.
Four ways to get rid of your overdraft
1) Aim to reduce it every month
Many people try this first, aiming to sort out their overdraft by reducing it by a bit each month. These ideas may help:
- get a good budget which you check before you spend money, not after. Look at apps that can help you check easily.
- making sure your partner is completely onside. You both need to be very determined to make this work if you have a joint account.
- have a general “money detox” which gives all your finances a boost and may remove some unwanted direct debits and standing orders you are currently paying.
But for many people, this “chipping away at it” approach simply doesn’t work for the months and years it would be needed for.
2) Clear it with a loan or balance transfer
This is “debt shuffling” not debt repaying. But as overdrafts are so tricky to pay off, you may find these simpler.
If your credit rating is ok, look at getting a cheap loan to pay off the old overdraft – that could save a lot in bank charges. Simple monthly installments – a good move if you are sure you can afford them.
Most 0% balance transfer cards will only let you clear a credit card balance, not move the money to a bank account. But there are a few money transfer offers around if you have a great credit score – although the length of the 0% is usually 18 months or less:
- if you can clear all or most of the card within that time, then this is the best possible way to get rid of your overdraft;
- if you don’t, then you are then paying the high credit card interest rate.
The biggest danger with the loan or a money transfer is that you just start dipping into the overdraft again. You could reduce the limit on this to try to stop this happening.
3) Switch to a new bank account
This is often the best way to solve an overdraft problem.
Sometimes you can transfer your overdraft to a new account where it will be cheaper, especially if your credit rating is good and the overdraft isn’t large. See MSE’s guide to the best accounts for people with overdrafts.
But if you can’t do this it’s still worth getting a new account – one where you intend to be in the black for all except a few days each year.
However bad your credit rating is, you can always open a “basic bank account”. Basic bank accounts are actually very good, with no charges. You get a proper debit card and mobile banking
So switch to using the new account for all your banking, Banks now make it easy to switch to them – it’s quicker and simpler that you may think. Have a look at the new challenger banks – Starling and Monzo have great apps that make it easier for you to budget well.
Then you can repay the overdraft in your old account a bit at a time. Make sure you pay in at least as much as the bank charges and it will start dropping every month. Or you could then use a loan or a balance transfer to deal with the old overdraft for good.
4) 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 at the moment 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 having another go at your overdraft. It needs to go at some point!
Has your bank increased your limit much too high?
Sometimes the reason you can’t get out of the overdraft is that it is simply too large. You may have been given a reasonable amount at the start, but then it went up and up.
Banks are supposed to only increase your overdraft limit if you will be able to afford the higher charges. But if your bank could see you were in your overdraft for much of the month, or there was a lot of gambling showing on your statements, or your credit record was poor, they should have known the higher limit would be too large for you.
Read Can you get refunds from catalogues, credit cards & overdrafts? for more about this and how to complain. If you win, you may get a refund of some of the charges you have paid.
Is your overdraft just part of a bigger money 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.
Talk to StepChange about how a DMP could work for you. They will explain if you have any better options.