How to use your bank overdraft effectively

Thursday, 03 March 2011 08:51

By Kate Saines

Overdrafts are often overlooked.

If we need to buy something we cannot afford we use our credit cards, or get a loan, often scouring the market to find the best rates, deals and offers available on these products.

But when it comes to the humble overdraft, it's just an attachment to our bank account. We often forget it's there – it just helps us out if our balance plunges below the zero mark.

And because it's just an extension of our account, we rarely shop around for the best deal.

In fact there is plenty of research showing overdraft facilities are far from the top of our list of priorities when looking for a new bank account.

Most of us, when switching accounts, look for a good in-credit interest rate or a bonus payment of some description.

Yet uSwitch found that nearly half of people who spend more than they earn rely on overdrafts to fill the gap between their income and outgoings.

This compared to 34 per cent who used credit cards for the same purpose.

So despite showing little interest in the details of our overdrafts, many of us are not only using them on a daily basis but relying on it as a buffer to aid our ailing finances.

So is it about time we started taking them more seriously?

The answer to this is yes, because if you don't know how your overdraft works you could have the potential to be hit with big fines.

But, also, if you have been using your overdraft for years without paying attention to the interest rate you might not be aware that there could be a cheaper alternative on the market which you can access by switching bank accounts.

Here's our guide to overdrafts, how you can find the best deal and what rights we have as consumers where they are concerned.

Use the Myfinances.co.uk comparison tables to find a better current account.

Pros and Cons

As with all financial products overdrafts can be incredibly helpful, but they also come with a variety of pitfalls.

The most obvious is that they come at a price. Many have interest rates which soar, above those offered on credit cards, to more than 19 per cent.

And, as many of you may have learned the hard way, there is the very pertinent issue of whopping daily fees which customers can be charged for unauthorised overdrafts.

"Unauthorised overdraft" is the term used to describe spending more than our overdraft limit.

It's easy to fall into the unauthorised zone as all it takes is a tiny overspend of as much as 1p and you will be in this territory.

Many banks have charged customers as much as £30 for falling into an unauthorised overdraft – and there has been a huge consumer campaign to prevent banks from doing this.

In 2009 the Supreme Court ruled the Office of Fair Trading (OFT) could not investigate whether banks had been unfair in hitting customers exceeding their limits with these charges.

Since then all sorts of developments have occurred in the overdraft world.

The good news is banks are being urged to make their charging structure more transparent – and many have taken this on board.

Take Santander, for example. It has just announced a new 'three tier' overdraft structure. It means that the more products you hold with the bank, the more preferential your overdraft rate will be.

And it also provides daily overdraft charges which are supposed to be easier for customers to understand.

Anyone who has their main banking relationship with Santander, in other words those with a current account into which £1,000 or more is paid per month, will be charged 50p per day for being in their overdraft, £5 per day for being in an unauthorised overdraft – and these will be capped at 10 days.

They will also be charged £5 and £10 for paid item fees and unpaid item fees respectively.

Those who don't have their main banking relationship with Santander and do not have an added value account will pay 50p per day for their overdraft, capped at 20 days, £5 per day for an unauthorised overdraft, capped at 20 days and £25 in fees.

Kevin Mountford, head of banking at Moneysupermarket.com, said: "For anyone who uses their overdraft regularly, this is one of the cheapest overdrafts on the high street.

"The industry has been moving to these types of fee structures saying they are easier for consumers to understand."

However, there is also a downside. Stefan Maryniak, personal finance expert at uSwitch.com, said: "Consumers need to be aware that it could lead to higher unauthorised borrowing charges than they're used to.

"Overdraft charges can be complicated with terms and conditions that can leave consumers baffled."

A recent survey by uSwitch found 24 per cent of consumers had been hit with charges because they did not understand the terms and conditions of a personal finance product, making the case for transparency even greater.

How to choose an overdraft

If you are a frequent overdraft user and you are looking for a good deal, the most important factor to consider is the interest rate.

Check your current overdraft rate and you might be surprised at how high it is – especially if you have had the same bank account for years.

Michelle Slade of Moneyfacts said: "Customers remain reluctant to switch current accounts, but it's a decision that could leave them out of pocket, as the biggest current account providers in the UK have some of the highest rates on the market."

She also said it was important, if you are a regular overdraft user, to prioritise accounts with low overdraft interest rates when looking for a new deal instead of being lured by big bonuses or in-credit rates of five per cent.

"Having an account paying a competitive rate of credit interest is not much use if you spend most of the month in your overdraft," she said.

Ms Slade reckons, however, you could save yourself hundreds of pounds by switching to an account with a competitive overdraft deal.

Financial research company, Defaqto, has highlighted Barclays Bank Account and Santander's Preferred Overdraft Rate Account as attractive because they both offer zero per cent on authorised overdrafts for a year.

Make sure, however, you check the small print before taking out these accounts. Make sure you are aware of the charges for unauthorised overdrafts and be aware these are only introductory offers – after 12 months you might want to switch to another fee-free account.

Where do we stand?

As well as a move for more transparent charging structures, we will soon benefit from even greater protection.

There has been an independent review of the Lending Code, which is the set of standards which govern major lenders in the UK.

As a result the code has been updated to include new provisions on customers' ability to opt-out from unarranged overdrafts.

This means customers can decide to opt-out from having an unauthorised overdraft, and instead of exceeding their limit, will simply have their transaction refused.

This update, coming in at the end of March, will hopefully be one step towards helping consumers avoid paying huge charges to banks and make overdraft management much easier for us all.

Use the Myfinances.co.uk comparison tables to find a better current account.

 

  

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