Significant changes are coming to the way banks charge you to use your bank account’s overdraft facility.
In this article, we’ll explain the upcoming changes, including the levels of interest you can expect to be charged and what you can do to limit the effect increased overdraft charges will have on your finances.
What are overdrafts?
An overdraft is a form of borrowing, where a lender – a high street bank or online money lender - makes extra funds available to the holder of a bank account.
An overdraft is intended to be used for short term borrowing only. When relied upon for the many months or years, overdraft usage incurs charges and interest payments, which mean costs can spiral and your level of debt can mount up, to amounts that could become unmanageable.
While overdrafts can be useful for when our payslips don’t quite cover our expenditure it looks like many people are going to need to start budgeting more carefully, to avoid paying increased fees and interest charges.
Overdraft changes 2020 – explained
The interest rates for overdrafts are set to significantly change in April 2020. Many lenders are set to double interest charges on authorised overdrafts.
The latest expected changes to overdrafts will come into full effect on April 6th 2020. However, some banks will already have changed the interest rates payable for using an arranged or unarranged overdraft.
There are two types of overdraft - an arranged and an unarranged overdraft. At present most banks operate two charging systems, with unarranged overdraft fees being significantly higher than those on the arranged overdrafts.
Whilst these changes are good news for many struggling to clear unarranged overdraft debt, it does mean the cost of arranged overdraft fees are set to heavily rise.
An arranged overdraft is when a bank account comes with an agreed credit line. The agreement between lender and borrower sets the available limit at a fixed amount. Despite this, arranged overdraft limits can be increased or decreased, depending on the needs of the borrower.
Arranged overdrafts often have associated charges. Normally, borrowers will be liable to pay a set monthly or annual charge for using the overdraft facility. Alongside this one-off fixed payment, borrowers are charged interest on the overdraft usage fee.
An unarranged overdraft is when you spend more money than is available in your account, without first agreeing on overdraft facility with your lender. Unarranged overdrafts fees are considerably higher than arranged overdraft fees and are payable daily.
So, if you are overdrawn on your account, you will pay a daily charge and interest for the money you borrow. These costs can quickly add up to significant sums - in fact, the interest charged here is higher than what you find for some credit cards.
Most overdrafts, both arranged and unarranged, will have a built-in buffer zone which means if you only go into your overdraft by just a few pounds, you won’t be charged.
Before going into an unarranged overdraft, it’s vital to check the maximum payable charge for going into your overdrafts. Most unarranged overdrafts have a monthly fee cap, which limits the overdraft usage fee and determines the level of interest you will be required to pay.
What you will be charged in April 2020
Check your account details for a full breakdown of costs, but it’s estimated that interest could be as high as 40%.
Student account overdrafts are interest-free, and some accounts will charge different levels than others, even if they are from the same lender.
Some rates will be determined by the borrower’s credit rating.
Why are these changes happening?
Changes to overdraft fees are coming into place to limit the amounts lenders can charge in interest fees for accounts without an arranged overdraft facility.
Those with an unarranged overdraft risk entering into debt, because the interest rates and charges demanded by lenders can often exceed even the levels set by payday loan companies, which are well-known to be a risky option for borrowers.
Unarranged overdraft costs can be tenfold those of payday loans in some cases.
The purpose of the overdraft reforms is to “fix a dysfunctional overdraft market”, according to the Financial Conduct Authority (FCA).
The FCA explains:
‘These changes will make overdrafts simpler, fairer and easier to manage and will protect the millions of consumers that use overdrafts, particularly the more vulnerable consumers.’
In 2017 lenders made £2.4bn from overdrafts - 30% of this came from unarranged overdrafts
Staggeringly 50% of the total unarranged overdraft fees collected by lenders came from just 1.5% of customers in 2016.
Who could benefit from these changes?
The overhauling of overdraft fees means that lenders can no longer charge more for unarranged overdrafts than arranged overdrafts. This measure is intended to protect the most vulnerable members of society, when they face unexpected costs or find themselves unemployed.
Due to the changes, lenders will now have to charge the same price for an arranged and an unarranged overdraft. The move will also see the banning of fixed fees for overdraft borrowing. This means consumers will no longer have to pay fixed daily or monthly charges and fees for using an overdraft facility.
Now, lenders will have to charge overdraft fees in a single annual overdraft price. This is beneficial to those having to pay extortionate daily charges for using an unarranged overdraft.
To put the changes into perspective, the FCA estimates that the typical cost of borrowing £100 on an unarranged overdraft will decline from £5 a day to less than 20p a day over an annual basis.
Additionally, from April, lenders must advertise associated overdraft costs with APR. This is intended to make comparing bank products easier than ever before for those shopping around for a better deal.
Can I switch bank accounts when in my overdraft?
Yes, it’s possible to switch accounts while still in your overdraft. Anyone with a good credit history that hasn’t gone over their arranged overdraft limit should be able to switch accounts relatively easily.
If you’re in your overdraft, you will be limited in the number of overdraft current accounts you can choose between. See our full guide to switching bank accounts in your overdraft to find the best overdraft to suit you, to learn how to switch and what you need to be aware of when switching.
If you’re on the lookout for a better deal, you can find the best deal available to you using our overdraft bank account comparison table.
Will those with arranged overdrafts be worse off?
The downside of these changes is that those with arranged overdrafts will be paying more in interest than before.
At present, most overdraft interest rates are set between 16-20%, but with the rate increasing to almost 40% across the board, those who regularly rely on the use of their overdraft facility could face significant charges.
For example, if your arranged overdraft facility was £1,000 and you were borrowing at an annual interest rate charge of 19%, you would have originally expected to pay £190.
From April 2020 onwards, your interest will effectively double due to the changes, so an example your 19% interest rate might rise to 38%. As a result, you’d pay a £380 annual interest fee for using your overdraft.
How can I pay off my overdraft?
Paying off your overdraft is the first step you can take to better manage your finances in 2020. You may choose to pay off your overdraft simply by improved budgeting.
To prepare for the overhaul to overdraft charges in April, check out our guide to how to pay off your overdraft quickly.
The importance of budgeting
Once you have paid off your overdraft, setting a budget and sticking to it will act as a preventative measure, to help stop you going into debt. There are a variety of budgeting tools and calculators available online to help you manage your finances more effectively
Explore our guide to the best 20 financial apps for budgeting, saving and smart spending.
Using these apps can help you create spending pots, to ensure you spend an appropriate amount of money on all your requirements - these could range from monthly subscriptions and rent to more day-to-day spending, including food and drink.
0% money transfer credit cards
Using this type of credit card, you can clear your overdraft. This is significantly lower than overdraft interest rates, however, as even when using credit, it is important to remain disciplined and only use credit for restoring your bank balance.
Once you’ve reset your overdraft to zero, concentrate on budgeting sensibly within your means, so you no longer need to borrow money between payslips, including repayment of the credit card debt. It pays to shop around for accounts with the lowest interest charges.
What if I’m in serious debt?
If you’re in more serious debt, perhaps you have an overdraft facility on more than one current account, and each one is maxed out. If this is the case, consider talking to debt management charities like Step Change, who can help you get back on your feet financially.
Make 2020 the year you take charge of your finances
However, the changes to overdraft interest rates affect your finances, with the changes coming into effect on April 6, 2020, now is the best time to get your finances in order.
If you’re able to prepare, by paying your overdraft off before the rule change is put in practice, you should act now to avoid paying more in the future.
Whether you will be better off due to the change or not, the increase of interest rates could serve as a wake-up call, ensuring you get a better handle on your finances. This includes improving how much you spend, save, what you owe and what you invest.
Always remember to compare bank accounts to get the best deal possible.