How Expensive are Overdrafts?

Many of us have an overdraft associated with our current account. These allow us to get our hands on more money than we actually have if we need it. So, we will be able to use a cheque, direct debit, transfer or cash withdrawal to get the money from our overdraft. This can sound pretty handy but there are costs. It is a good idea to have a think about the costs to make sure that you make wise decisions when you are thinking about whether you use your overdraft facility or not.

Interest

The way overdrafts are charged for in the UK has recently changed in order to make it easier to compare the different banks. It used to be the case that there were different types of overdrafts (authorised and unauthorised) with different costs but this is not the case anymore. Due to a change in the law to make things easier for borrowers all overdrafts have just the one cost and that is the interest that is charged on them. There are no fees and charges to confuse matters, you just have to pay interest. This interest rate will vary between the different lenders but it tends to be between 35% and 40%. This sounds high and this is because it is. It is the interest rate for the year, which means that if you have a £100 overdraft for a year, you will be charged £40 across the year which would be £3.33 a month. It seems pretty small when you look at the monthly figure, but you can see also, what the impact is of keeping the overdraft for a long time.

Repaying

Overdrafts do not have a repayment schedule. They will be repaid when money is put into the current account that the overdraft is on. This means that whether you get paid a salary, benefits or some other money goes into the account, it will repay some or all of the overdraft. This means that if you are operating a normal current account, that you are likely to repay some or all of what you owe when you get paid, which will probably be monthly. This means that it is quite easy to repay and not something that you will need to remember to do. However, it also means that it is easy to forget to pay it off as well.

There are some people that will not repay their overdrafts and use them like a personal loan. They will take out a second current account for their salary to be paid in to and leave the overdraft just accumulating interest all of the time. This might seem like an easy way to get some money but it is something that you should think very strongly about. You will be paying that interest all of the time and it is a really high amount. There are ways to borrow money which have much cheaper interest rates and so it can be a good idea to look into these rather than trying to keep an overdraft for a long time. You will usually find that a personal loan will be cheaper than this and a credit card might even be a cheaper way to borrow.

With other methods of borrowing you are encouraged to repay some of what you owe. This can help you to make sure that you do not stay in debt for too long. With an overdraft this does not happen and that means that you could keep owing the money for a very long time and building up those interest charges. It can cost you a lot of money and is therefore not a wise idea.

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