What Is an Overdraft?

In layman’s terms, being overdrawn, or getting an overdraft, is when you exceed the amount that you have in your bank account.

Being overdrawn is normal, but picking the wrong current account can mean paying far more than you should in charges when you overdraft.

Types of overdraft

An overdraft is distinguished into two, and the difference between them is fundamental:

Authorised overdraft

Authorised overdrafts are pre-arranged with your bank. If you have an authorised overdraft, this means you have set an overdraft limit for your account. You will typically have to pay a fee or an interest in return for using an overdraft facility, although some banks do give interest-free overdrafts.

Unauthorised overdraft

This is where you have not consented to an overdraft facility with your bank in advance and have spent more money than you possess in your account, or you have used more than your authorised overdraft limit.

Unauthorised overdrafts should be avoided because they are usually subject to fees which can be costly.

Taking advantage of an overdraft

Overdrafts can be a helpful way to loan small amounts of cash for a short period. However, overdraft is not an effective way of borrowing in the long-term, because they almost always come with a higher interest rate than some loans and even some credit cards which are already high.

It can be helpful to have an overdraft facility arranged with your bank even if your current account is constantly on credit.

Having an overdraft can play as a buffer to avoid fees for unauthorised borrowing if you accidentally overspend or find yourself needing a little more fund. Accounts with fee-free overdraft are useful for this type of technique.

What to do if you depend on your overdraft?

If you are constantly overdrawn or regularly go overdrawn without authorisation then you should check to see if you are getting the best deal on your current account, as you could be spending far bigger than you need to in fees or charges.

If you have a large overdraft and you cannot or do not want to shift to an interest-free overdraft account, you could consider switching your overdraft to a less expensive type of loaning.

You could consider getting a personal loan (secured or unsecured loans) at a moderate rate of interest than you are spending on your overdraft.