Overdrafts are perhaps the simplest form of borrowing money from a bank or financial institution of any kind.
However, just because taking out an overdraft is easy doesn’t mean it shouldn’t be carefully considered prior to the decision.
In this post, we’ll be discussing the basic principles of how an overdraft works and how to ensure you avoid the penalties of not paying back your overdraft on time.
- How Do Overdrafts Work
- Types Of Overdrafts
- What Happens If You Try And Go Over An Overdraft
- What To Do If You’re Struggling To Pay Back Your Overdraft
- How To Avoid Overdraft Fees
How Do Overdrafts Work
An overdraft is designed to give you the opportunity to spend more money than you currently have in your bank account.
Provided this is a pre-arranged overdraft then this will be a limited amount which is agreed between you and your bank or financial institution in advance.
In return for the overdraft, it’s likely you’ll have to pay some form of interest on the money you borrow. Although some banks offer a zero percent overdraft – meaning you’ll pay no interest on the money you borrow provided you remain within the terms and conditions of the agreement.
Types Of Overdrafts
Primarily, there are two types of an overdraft, and they are the authorised overdrafts and unauthorized overdrafts;
Authorised overdrafts are organised in advance with the bank or lending facility. In this case, you’ll agree in advance the borrowing limit and associated interest rates and other terms and conditions.
An unauthorised overdraft is when you spend more money than you currently have available in your account without getting any permission or pre-approval from the bank or lending facility.
This can also happen when you go over the limit of the arranged overdraft with your bank. I.e. you agree with the bank an overdraft of £500 but actually, end up spending more money than you have and therefore have more than the pre-arranged minus £500 in your account.
These kinds of overdrafts come with additional fees and charges, which are not just interest-based but often include an additional set fee per day. All of this is alongside a negative impact on your credit rating. Exactly, what charges and impact will depend on the bank’s terms and conditions.
What Happens If You Try And Go Over An Overdraft
If you try to withdraw or spend more money than the pre-arranged overdraft then the following is likely to happen;
- You’ll be asked to pay a pre-set penalty charge. Likely per day in which you are breaching the terms and conditions of the overdraft.
- You will be charged an increased interest rate.
- You may have your bank account frozen.
The exact consequences depend on the bank’s overdraft terms and conditions – each bank and even specific bank account is often slightly different.
What To Do If You’re Struggling To Pay Back Your Overdraft
As an overdraft is such an easy form of borrowing it can often be overlooked, however, there are still multiple negative impacts to be had personally should you not make the minimum repayments of your overdraft that are set out in the terms and conditions.
So, if you’re struggling to pay back your overdraft (or any other kind of debt) here are some things to you can do;
Get Financial Advice
If you’re struggling to make ends meet then there are a number of free financial advice services available that can help you in various different ways.
These are licenced professionals who will provide personalised advice based on your circumstances.
Make A Complete List Of Your Debts
You should begin your debt plan of attack by listing out all the debts you have.
Depending on the method of attack you may want to re-arrange the list in the following different ways;
- The larges amount owed to the smallest amount owed (snowball method)
- The smallest amount owed to the largest amount owed (avalanche method)
- Largest interest rate to smallest interest rate
However, you’ll also want to ensure you have an understanding of the priority and non-priority debts. Priority debts are the ones that can have the largest impact on your life and include consequences such as;
- Being visited by bailiffs
- Receiving a court summons
- Having your heating or lighting cut off
- Being made bankrupt
- Losing your home
Prioritise The Debt You Want To Pay First
You’ll want to budget to pay the minimum amount towards each debt as required (each amount will be personal and set by the lender if you’re unsure speak to the lender directly).
This will help you to avoid any penalties for missed payments.
From there you’ll want to choose your debt repayment method style.
Redefine Your Budget
In order to get out of debt, you’re going to need to spend significantly less than you make. Using that financial difference you’ll be able to pay back what you’ve borrowed.
In order to achieve this, you’re going to need to set a budget. Only then will you be able to see how much you’re earning, spending and what you’re spending all that money on.
I’ve covered multiple different budgeting applications that can help you get started, however, my personal favourite has to be YNAB.
How To Avoid Overdraft Fees
There are certain instances where you’ll be able to minimise or remove overdraft fees altogether.
Firstly, by using a comparison service to find the best overdraft or lending facility that suits your budgeting needs. You’ll want to be looking for one that meets your requirements, but also has a low-interest rate.
In some cases, banks offer an introductory zero percent interest to try and entice you into lending with them. These can work in your favour provided you have a good credit rating and are able to pay the debt off before it comes interest chargeable.
If you do have to take out an overdraft or debt with fees then you can minimise them by keeping a record of your spending and when the minimum debt repayments are due. This will ensure you’re always aware of when the money is owed, how much is owed and is likely to help you pay the debt off in time.
Be sure to set up online or mobile banking and get up to date alerts on your spending so you can keep track of where your money is going and how much you owe.
If you’re worried you might forget to pay back your overdraft then you can often set up a direct debit to pay the full or minimum balance off automatically in advance of the payment being due.