Before You Use an Overdraft: Why the New Fee Rules Still Catch People Out

How overdraft pricing changed in 2020

The FCA mandated that from April 2020, banks must charge overdrafts using a simple annual interest rate expressed as an EAR (effective annual rate) rather than daily fees, fixed charges and other complex structures. This was intended to make overdraft costs more transparent and comparable. Most major banks now charge between 19 and 40 percent EAR on arranged overdrafts.

The risks most people do not check

Overdrafts remain very expensive. A 39.9 percent EAR overdraft costs significantly more than most credit cards and far more than a personal loan for the same amount. Using an overdraft as a regular credit facility rather than an emergency buffer is expensive. For regular credit needs, a personal loan or 0% purchase credit card is typically much cheaper.

Unarranged overdrafts remain expensive and damaging. Going beyond an arranged overdraft limit, or using an overdraft on an account without an arrangement, results in higher rates or charges and a negative marker on your credit file. Banks are required to charge the same rate for unarranged as arranged overdrafts under FCA rules but unarranged use is still flagged.

Overdraft use is visible to lenders. Regular overdraft use appears on bank statements and credit files and is assessed by lenders as a sign of financial stress. Mortgage lenders review bank statements as part of affordability assessment and consistent overdraft use can affect an application.

Buffer zones and grace periods vary by bank. Some banks offer a small interest-free buffer (typically £20 to £50) before charging overdraft interest. Others charge from the first penny. Check your specific bank's terms.

What to verify before relying on an overdraft

Check the EAR on your arranged overdraft and compare it against personal loan rates for the same amount. If using the overdraft regularly for monthly cash flow, consider whether a personal loan at a lower rate would be more economical. Ensure any overdraft is formally arranged rather than going unarranged.

Where to complain

Overdraft charge disputes go to the Financial Ombudsman Service after the bank's internal complaints process.

Frequently asked questions

What is the difference between an arranged and unarranged overdraft?

An arranged overdraft is a pre-agreed facility with a set limit. An unarranged overdraft occurs when you go beyond the arranged limit or use an overdraft facility on an account without a formal arrangement. Both are charged at the bank's EAR but unarranged use also creates a negative marker on your credit file.

How does the FCA's 2020 overdraft rule change affect me?

Banks must now charge overdrafts as a simple annual percentage rate rather than through complex daily fees, fixed charges and other structures. This makes overdraft costs easier to compare between banks. However, rates at major banks are typically between 19 and 40 percent EAR, which is still expensive credit.

Can a bank reduce my overdraft limit?

Yes. Banks can reduce or remove overdraft facilities with notice, typically 30 days for a reduction. If you rely on an overdraft, having a reduction imposed unexpectedly can create cash flow problems. Do not rely on an overdraft as a long-term credit facility.

Does overdraft use affect my credit score?

Arranged overdraft use within the agreed limit does not directly damage your credit score. However, consistent use of the full overdraft limit, unarranged overdraft use, and overdraft use visible on bank statements reviewed for mortgage applications can negatively affect credit assessments.

What is a better alternative to an overdraft for regular credit needs?

A personal loan at 5 to 15 percent APR is significantly cheaper than an overdraft at 19 to 40 percent EAR for regular credit needs. A 0% purchase credit card cleared monthly is cheaper still. An overdraft is best reserved for short-term emergency cover of a few days to a week.