How to best use overdrafts

The overdraft is the original credit product and was first created in the early 1700s. Given they are almost 300 years old, it’s not difficult to imagine how much overdrafts have changed throughout their lifespan. The unchanging factor is that overdrafts allow you to withdraw more from your bank account than your current available balance.

Overdrafts have helped people manage cashflow and surprise expenses for years, and the most recent reform means they are now much more affordable. This was a significant change because prior to the reform, unarranged overdrafts could cost up to eight times more than payday loans, often affecting those already on low incomes or in vulnerable circumstances the most.

Even though overdrafts are now more affordable, they’re still a type of borrowing and you have to be responsible when using credit. As they are so easily accessible, it can be easy to use your overdraft without realising, and often this lands people in tricky positions or with balances they can’t repay. There are better ways to manage your overdrafts and to ensure you stay on top of your finances, so we’ve shared a few easy tips below.

Best ways to use your overdraft

• Aim to repay the balance in full every month
• Change the way you think about your overdraft
• Reduce or cancel your overdraft to avoid temptation
• Open a new bank account to help you manage your finances

Repay the balance in full

Some months, this simply won’t be possible – if you’ve borrowed £500 because you needed a new fridge, it’s unlikely you’ll be able to reimburse this in full on your next payday. But the smaller expenses should be factored into your budget so that you pay off your overdraft every month. If you do have a large overdraft balance, create a solid financial plan to repay it over the next few months. Because it’s so easy to spend your overdraft without realising, it’s important you find a sustainable way to manage the repayments and bring your balance back to £0 within a short timeframe. It might help if you think of your overdraft debt as a reduction in next month’s wages – as the overdraft is automatically repaid with any incoming payments, by using your overdraft, you’re reducing the amount available when you next get paid. For example, if your overdraft debt is £300, and you are due to be paid £1200, you’ll only have £900 to spend that month without going back into your overdraft. If your priority bills and non-essential expenditure account for more than £900, try to budget to repay £100 each month, so instead of spending your full salary of £1200, you only spend £1100, then in 3 months you’ll have fully repaid your overdraft.

Change your mindset

It’s easy to think of overdrafts as an extension of your current bank balance, but overdrafts are in fact a type of credit. You are borrowing money from the bank and you have to repay the balance at some point – often with interest. Whenever you’re about to use your overdraft for non-emergency expenses, consider if the purchase is necessary and if it can wait until payday. While overdrafts are considered affordable credit and therefore you needn’t be so stringent with the uses, you should still think of it as borrowed money. Every time you use credit, you are borrowing from your future self.

Reduce or cancel your overdraft

While you may be approved for a set overdraft limit when you open a new bank account, you don’t have to keep the overdraft at all times. You can ask the bank to close the overdraft facility at any time if you find you suffer from temptation and don’t always make the most sensible financial decisions. There’s no shame in having no overdraft if it means you can better manage your money and avoid unnecessary debt. If you need the overdraft to help meet monthly payments that don’t line up with your payday – for example, if you are paid four-weekly but your utilities are due on a set date each month – then you can simply reduce the limit instead. If your overdraft limit is only the amount you need to manage your cashflow throughout the month, you might find it easier to manage buying impulses and reduce your credit dependency for non-essential purchases.

Open a new bank account (without an overdraft)

If you’ve already accrued a large overdraft balance, consider opening a new bank account without an overdraft facility to help you pay it off. It might seem counter-productive at first, but if your salary is not immediately allocated to your overdraft, you can create a realistic financial plan to repay the amount you owe each month – a bit like you might do with a credit card. This way, you’ll be less likely to continually increase the amount you owe because you won’t have the facility to accidentally use. If you are struggling with repaying your overdraft, you should always get in touch with your bank as soon as possible. They will be able to advise you on the options available to help you repay your balance. If you find you’re really struggling or starting to see your mental health affected by your overdraft debt, consider contacting a free debt advice charity.

As well as overdrafts, there are other common loans and credit facilities that can be accidentally mismanaged. Many people probably don’t know how to use credit cards correctly, which can be surprising when you consider how many adults in the UK use a credit card.

Whatever your preferred or most-easily accessible type of credit is, spend a few minutes each week ensuring you are not only using the facility in the best way, but also that you’re using the cheapest version. Quick searches using comparison sites can show you in seconds how much you could save by using an alternative bank or financial institution. Some products you can’t transfer, but you can switch mortgages and energy services easily, and even a balance transfer credit card could save you some cash compared to your current interest rate.

Unfortunately, money management isn’t most people’s favourite task, but the more time you can devote to research and product comparisons, the more money you’ll save in the long run – soon, you might not even need an overdraft!