The New Overdraft

About 19 million people use an arranged overdraft each year, and 14 million use an unarranged overdraft each year which means most of you are probably aware of what an overdraft is and how it can help you out in times of unexpected financial difficulty. Until recently, the costs of borrowing through an unarranged overdraft was incredibly high and disproportionately affected those on low incomes who may be considered as financially vulnerable.

On 6th April 2020, the FCA introduced new regulations to the overdraft market in an attempt to make it easier for customers to compare overdraft charges and to make overdraft costs clearer.

Unarranged Overdraft vs Arranged Overdraft

An overdraft is an attachment to your normal current account which allows you to make purchases even if you don’t have the funds in your account to do so. An unarranged overdraft is similar, except it hasn’t been authorised by the bank and therefore is subject to additional charges.

Changes to the Cost of Borrowing

Up to 6th April 2020, some banks were charging as much as £56 to borrow £100 over the course of a week through an unarranged overdraft, compared to almost nothing if the overdraft was authorised. Thanks to the new rules implemented by the FCA, it now costs as little as 65p.

However, not everyone will benefit from these new changes. Customers who had a 0% or very low interest rate overdraft may have seen their interest rate, and therefore the cost of borrowing, increase quite dramatically. This is because all of those customers are now seeing the true cost of borrowing.

Who will benefit the most?

The people who will benefit the most are those who couldn’t get an arranged overdraft either because their income was too small, or their credit history was too poor. Now, hopefully those people will have a better chance of controlling their finances as they’ll be able to borrow through their unarranged overdraft without facing severe financial difficulty as a consequence.

While you should never borrow money if you don’t need to, sometimes unexpected bills can arise, and we really have no choice but to pay them. If you aren’t fortunate enough to have an emergency cash fund, then borrowing the money will often be the only way you meet the payment. It’s unfair then that some people should have to pay as much as £56 just because their credit file isn’t brilliant.

The Main Changes

• Banks will no longer be able to charge higher interest rates for unarranged overdrafts than for arranged overdrafts
• Banks will charge a single annual interest rate
• There will be no more daily or monthly fees for using an overdraft

Generally, across the sector, most banks have now confirmed that their overdraft interest rate is 39.9% APR (Annual Percentage Rate) which means it will cost you £39.90 to borrow £100 for a whole year. This is quite clearly an improvement on previous unarranged overdraft fees, however many people who are used to having a 0% overdraft are now seeing the cost of that overdraft increase.

Because banks can no longer charge daily fees or monthly fees, it should be easier for customers to compare the costs of overdrafts from different banks.

What to do if your overdraft fees have changed

If your overdraft fees have changed and you’re not clear on how you are now being charged for using your overdraft, then the best thing to do is get in touch with your bank and find out. All the information should be in some form of correspondence sent before the changes were implemented, whether this be by email or by post, but if you require further clarification then your bank should be able to provide this.

If your overdraft fees have increased, then it’s probably a good idea to start looking around to see if there are any cheaper alternatives to match your borrowing pattern. Overdrafts were not designed to be used for long-term or large borrowing so something like a personal loan might be more suitable in this case. Alternatively, there are low interest credit cards available and even credit lines if you’re now looking for a cheaper alternative to overdrafts.

You shouldn’t have to feel pressurised into staying with your bank or maintaining the use of your overdraft if you don’t want to – you can ask to have your overdraft cancelled as long as your account is in credit. If you do decide to do this, then try not end up using an unarranged overdraft – maybe try and save a bit of cash for future unexpected emergencies or try and budget so that you can reduce your dependency on your overdraft until you barely use it at all. Trying some easy saving tips every now and then will also help improve your overall money management.