What is an overdraft?
An overdraft is a short-term credit facility that allows you to spend more than you have in your current account. When you open your account, your bank lets you know how much you can borrow and how much it will cost in interest charges.
This is known as an arranged or authorised overdraft. Spend more than your arranged overdraft limit, and you’ll move into an unauthorised overdraft (which attracts higher fees and changes).
Overdrafts are one of the main benefits a current account offers, which explains why around 15 million of us use this form of borrowing. They’re an essential tool, shoring-up monthly spending until the next payday.
The problem with overdrafts
The problem with overdrafts is that it’s all too easy to keep spending even when your balance has hit £0, and any spending after that point usually attracts interest, which only adds to the amount you owe.
The problems don’t start and end with these financial woes. Having an overdraft for a long period or slipping into an unarranged overdraft can damage your credit score, which makes it harder to get a loan, mortgage or credit card.
Switching your bank account to one where you pay less interest on your overdraft allows you to work on clearing your debt more quickly.
What should you look for in a new account?
If you’re in the red and looking to switch banks, focus on the overdraft interest charges first. Benefits such as what you’d earn if you had a positive balance might not be relevant to your situation and you can investigate that more once you’re back in credit.
The best accounts with an overdraft are those that charge the least in interest fees. For example, if your bank charges you 39.9% AER, and you can open an account charging 35% AER, you’ll pay less interest.
Even better, you might be able to open an account that offers an interest-free buffer with interest only charged if you exceed this limit.
To put this in context, consider the following scenarios for someone with a £500 overdraft:
How do you go about switching?
Switching banks with an overdraft is straightforward, thanks to the Current Account Switch Service introduced in 2013. It’s free to use and requires very little effort – just follow these steps:
Contact your chosen bank and apply to open your preferred account.
Pick a switch date. This is when the bank will redirect your balance, Direct Debits, standing orders, income salary and benefits payments to your new account.
Wait. You can continue to use your old account as normal; just don’t set up any new payments during this time.
If anything goes wrong after switching, your bank will correct the problem and cover any costs, as set out in the Current Account Switch Guarantee.
Note: In the case of a joint account, both holders must give permission for the switch.
What should you consider after switching bank accounts?
If your application is successful, you’ll benefit by not paying as much interest as before. However, your debt will still be there and needs addressing – especially if it’s approaching your arranged overdraft limit, after which you’d face even steeper charges or a block on your spending.
To avoid this happening, consider the following routes out of debt:
Start budgeting: work out what you have coming in each month, and find ways to ensure you don’t spend it all. Ensure you cover priority debts, such as the rent, mortgage, Council Tax and utility bills. Try to cut back on all non-essential spending and cancel subscriptions.
Use a 0% transfer card: take out a money transfer credit card. This option lets you transfer money into your current account, clearing your overdraft. Just ensure you clear the amount owed on the card before the 0% deal expires, or you’ll be back where you started.
Get a personal loan: If you can’t get a 0% money transfer card, you could get a personal loan. Loans typically should charge a far lower interest rate than overdrafts and can run for a year or more, giving you more time to repay.
Contact your bank: Explain your situation and ask whether they can help. For example, you may be able to get your overdraft charges frozen, making it easier for you to chip away at the debt.
Get independent advice: Debt charities such as Citizens Advice and StepChange will be able to help you draft a letter to your bank and offer useful advice and tips for tackling your overdraft.
Can you always switch banks with an overdraft?
The Current Account Switch Service covers 99% of current accounts, meaning the chances of finding one that’s not part of this scheme are slim. Even so, there is no guarantee that every person seeking to switch bank accounts with an overdraft will be successful.
Banks may be willing to take on customers with overdrafts, but their decision will depend on each applicant’s level of debt and credit score. This is why you must consent to them checking your credit report.
Your application may be rejected if you have a poor credit rating – perhaps because you have a history of missing mortgage or rental payments. In this case, you should consider other ways of clearing your debt - like those mentioned above.
