How To Tackle Your Overdraft Today!

by Jane Baker on 16 December 2008  |  14 comments
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If you regularly slip into the red on your current account, here’s how to banish your overdraft once and for all!

Did you know overdrafts can be one of the most expensive ways to borrow? Authorised overdrafts can cost you a small fortune. And don’t even think about wandering into dangerous unauthorised borrowing territory. The costs for exceeding your overdraft limit can really make your hair stand on end.

Unfortunately for regular overdraft users, there’s no connection between today's ultra low Bank of England base rate -- currently just 2% -- and the rates banks charge for slipping into the red on your current account.

Although some homeowners with tracker mortgages and standard variable rate mortgages are enjoying lower interest rates following the recent base rate cuts, the same can’t be said for other types of credit.

In my recent article Loans Aren’t Getting Cheaper, I explained the falling base rate has had no impact on the cost of personal loans. It’s a similar story for overdrafts too. In fact, according to Fool partner Moneyfacts, some banks have actually put overdraft rates up. Now that hardly seems fair to me.

Moneyfacts say Smile has increased overdraft rates on its Current Account by 4% over the last year from 11.9% to 15.9% EAR. Meanwhile Abbey charges 3% more interest on The Abbey Current Account overdraft than it did 12 months ago, as does Nationwide on the FlexAccount.

So let’s take a look at just how high the latest overdraft interest rates are on a dozen popular current accounts:

Current account overdraft rates

*EAR = Effective Annual Rate. This is the rate you would pay if it was charged and compounded each year. Using EAR lets you make a fair comparison between accounts where interest may be charged at different frequencies.

Abbey and HSBC are the worst offenders in this selection with ultra-high overdraft rates of almost 20%. If you tend to go into the red on your current account every month, these rates could add up to a pretty hefty interest bill.

But it’s not all bad news. Current accounts from Alliance & Leicester offer a fantastic 0% AER on your overdraft for the first 12 months, up to a maximum of £2,500. A&L accounts will give you a whole year to climb out of the red, so it could be worthwhile switching your existing current account over.

Don’t forget, if you still tend to go overdrawn after the first year, Alliance & Leicester will charge a usage fee of 50p a day, with a maximum monthly charge of £5.

If your overdraft doesn’t usually climb too high by the end of the month, you could make use of a current account which offers a small interest-free overdraft buffer. With the First Direct First Account, for example, you’ll get an interest-free overdraft of £250. Although, you’ll be hit with an interest rate of 15.9% once your account is more than £250 overdrawn.

What if you don’t want to switch your current account?

If you’re quite happy with your current account -- with the exception of an eye-watering overdraft rate -- what are the alternatives?

One option is to move your overdraft onto an interest-free credit card instead. This works in much the same way as transferring an existing credit card balance to a 0% deal.

There aren’t many credit cards which allow you to do this, but one which does is the Virgin Money Credit Card. Virgin will pay money into your current account which effectively clears your overdraft. You’ll then have a full 16 months to repay this amount without paying a single penny in interest. That knocks the spots of your average current account overdraft facility.

That said Virgin will charge a 2.98% transfer fee. If you have an overdraft of say £1,500, the fee will set you back £44.70.

Don't boost bank profits!

So if you have an overdraft which you dip into regularly, don’t get stuck with a sky high rate. This type of credit is certainly a great way for banks to boost their profits. I don’t think you should let them get away with it!

And, on a final note, think about cancelling your overdraft facility once it has been cleared. That could help you steer clear of running up a new debt on your current account.

More: Make The Most Of Your Current Account | Compare current accounts at The Fool