How does an overdraft work?
An overdraft is a credit facility that allows you to borrow more money than you have in your current account.
Previously, there were two types of overdraft, and these carried different interest rates and fees:
Sometimes called authorised or formal overdrafts, these are agreed with your bank in advance up to your overdraft limit, which will be reviewed on a regular basis.
Sometimes called unauthorised or informal overdrafts, this is when you go overdrawn past your arranged overdraft limit, or (if you don’t have an arranged overdraft) when your balance falls below £0.
Banks used to charge as much as £10 per day for unarranged overdrafts but, as of 6 April 2020, they can no longer penalise customers who go over their overdraft limit. Banks are also banned from charging daily or monthly overdraft fees.
However, a handful of banks - Tesco Bank, TSB, NatWest and RBS - will still impose a fixed returned item fee if there aren't enough funds in your account and a payment bounces (we make a note of these fees in our tables).
Banks with cheap or free overdrafts
Banks and building societies changed their overdraft structure to comply with new Financial Conduct Authority (FCA) rules on overdrafts from April 2020.
Many lenders are charging customers as much as 39.9% AER but there are still better deals available if you think you will need to use an overdraft from time to time.
This table lists the current accounts with the cheapest overdrafts based on a scenario of borrowing £500 for seven days (excluding accounts reserved for private banking customers).
|Provider||Account name||Arranged overdraft charges (EAR)||Cost of £500 overdraft for one week|
Recommended providerStarling Bank
Starling is replacing its flat rate of 15% with a rate of 15%, 25% or 35% EAR dependent on your credit score from 1 April 2020. Only those with excellent credit scores will be offered 15% EAR though its higher rates still beat the high street banks. Starling uses TransUnion and Equifax to decide what overdraft rate to offer customers. Pricing will be reviewed on a monthly basis (though your rate will only change once in any 12 month period).
|Current Account||88%||15% |
Could be 25% or 35% depending on credit score
Recommended providerFirst Direct
First Direct will continue to offer a 0% overdraft on the first £250 borrowed but as of 14 March 2020, customers pay 39.9% EAR beyond this, up from 15.9% previously.
|1st Account|| |
0% under £250 then 39.9%
Recommended providerM&S Bank
M&S Bank increase it's 0% overdraft buffer from £100 to £250 on 14 March 2020 but you pay 39.9% EAR beyond this, up from 15.9% previously.
|Current Account||77%||0% under £250 then 39.9%||£1.61|
Monzo has removed its daily overdraft fee of 50p per day and replaced it with a rate of 19%, 29% or 39% EAR dependent on your credit score. Monzo will use TransUnion to decide what overdraft rate to offer customers. The bank told Which? that it doesn't proactively change anyone's overdraft rate so if your credit score improves, you would need to pay off your overdraft and re-apply to get a better deal.
|Current Account|| |
Could be 29% or 39% depending on credit score
Data correct as of January 2021
Which? Customer Score: Our rating for customer satisfaction, based on feedback from real customers. The score is made up of a customer's overall satisfaction with the brand, and how likely they are to recommend that brand to a friend. We surveyed 4,501 members of the general public in September 2020. Our full table includes scores and star ratings for all banks.
Some banks offer interest-free 'buffers' which means you don't face any charges if you borrow up to this amount:
The best banks for overdrafts in detail
Starling 15% EAR overdraft - if your credit rating is excellent
Mobile and online-only bank Starling offers the cheapest arranged overdraft on the market but only if you have an excellent credit score.
Starling previously offered a flat rate of 15% to all customers but from 1 April 2020, overdrafts have been charged at 15%, 25% or 35% EAR dependent on your credit score.
This approach means that different customers are offered different interest rates, with Starling Bank estimating how much of a risk there is that customers won’t be able to pay back what they’ve borrowed.
For customers who face a new rate of 25%, overdraft charges for borrowing £500 for seven days have increased from £1.35 to £2.19, while those paying the highest rate of 35% will be charged £2.97.
The maximum overdraft will remain at £5,000, subject to status.
More about Starling
Starling uses credit reference agencies TransUnion and Equifax to help it decide how much to charge you and rates will be reviewed on a monthly basis (though your rate will only change once in any 12 month period).
The bank sends instant notifications when you’re using your overdraft and you can use the app to see how many days you’ve been in your overdraft, and how much interest you’ve accrued.
Starling is a Which? Recommended Provider. It received the highest customer score of any bank in our 2020 survey and offers current account perks including free spending and cash withdrawals abroad.
- Find out how to improve your credit score
First Direct and M&S Bank 0% overdraft up to £250
First Direct and M&S Bank both offer an interest-free overdraft of £250 on their standard current accounts.
However, if you borrow more than £250, you’ll pay 39.9% EAR.
Both banks used to charge a market leading overdraft rate of 15.9% EAR. These changes have meant the cost of borrowing has more than doubled for some customers.
More about First Direct and M&S Bank
Both First Direct and M&S Bank are Which? Recommended Providers, receiving high scores in our 2020 customer survey, and offering perks including regular saver accounts.
Bear in mind that First Direct shares deposit protection with its parent bank HSBC.
M&S Bank is part of the HSBC Group but operates under its own license so you are entitled to full protection up to £85,000.
- Here, we explain how the Financial Services Compensation Scheme protects your deposits.
Monzo 19% EAR overdraft for some
Previously, Monzo charged a daily overdraft fee of 50p but this was replaced with a rate of 19%, 29% or 39% EAR dependent on your credit score.
The bank allows customers to borrow up to £500 only. You can change your overdraft limit from the app at any time. If you want to cancel the overdraft you must pay the amount you borrowed back, plus any interest owed.
More about Monzo
Monzo uses TransUnion to decide what overdraft rate to offer customers.
It doesn't proactively change anyone's overdraft rate so if your credit score improves, you would need to pay off your overdraft and re-apply to get a better deal.
Nationwide FlexDirect 0% for a year
Though Nationwide's FlexDirect account offers an interest-free overdraft for a full year, we haven't included it in our table because after this, you'll be stung with a rate of 39.9% EAR.
Don't switch to this account if you aren't confident you can clear the overdraft debt within a year.
If you’ve held a FlexDirect account in the past 12 months, you won’t be eligible for the interest-free overdraft.
More about Nationwide
This account also rewards you for being in credit - if you pay in £1,000 or more a month, you'll earn 2% on balances up to £1,500 in the first year, then 0.25%.
Worst banks for overdrafts
We previously ranked the worst banks for overdrafts, based on interest rate and fees.
But since the FCA's new rules came into force in early 2020, the vast majority of banks now charge 39.9%. Lloyds is charging some customers an eye-watering 49.9% EAR
If you regularly dip into your overdraft with these banks, consider switching to one of the banks with an interest-free buffer mentioned above.
If you've been using your overdraft for an extended period, consider speaking to a debt advice charity such as StepChange.
What rules do banks have to follow on overdrafts?
Which? has repeatedly reported that unarranged overdraft charges can be more expensive than using a payday loan, and we’ve been campaigning to get banks to bring them in line with those for arranged overdrafts.
The Financial Conduct Authority (FCA) eventually stepped in, announcing new rules to fix the ‘dysfunctional’ overdraft market, in force from 6 April 2020.
This means banks and building societies must:
- stop charging higher prices for unarranged overdrafts than for arranged overdrafts;
- scrap fixed daily or monthly charges and fees for having an overdraft facility;
- price overdrafts by a simple annual interest rate to help customers compare them against other products;
- to do more to identify customers who are showing signs of financial and implement a strategy to reduce repeat overdraft use.
Introducing a flat rate puts prevents banks from making large profits on the backs of the most financially vulnerable. However, the FCA has stopped short of placing a cap on the cost and some of the largest banks are introducing rates as high as 39.9% AER.
This prevents banks from making large profits on the backs of the most financially vulnerable, however, some customers will see the cost of borrowing rise steeply.
Other measures to improve overdrafts
As well as forcing banks to ditch unarranged overdraft fees from April 2020, the FCA has identified and implemented other measures to increase customers' engagement with their overdraft usage and charges.
Led by the retail banking market investigation of the Competition and Market Authority (CMA) in 2016, the FCA wants banks to improve understanding and management of overdrafts through:
- Text message or push notification alerts warning of potential overdraft charges - the CMA announced in May 2020 that five current account providers have refunded £47m in two years for breaching this rule.
- Online and in-app tools to assess eligibility for overdrafts without appearing on credit reports.
- Online calculators to show the cost of overdrafts for different patterns of use.
- Banning showing overdrafts as 'available funds' to ensure that overdrafts are presented clearly as debt.
Read more in the FCA's final report into overdrafts and other forms of high-cost credit.
Is it bad to use an overdraft?
Firstly, not all overdrafts cost the same, as you can see from the tables in this guide.
Secondly, overdrafts are a very flexible form of credit, because you’re free to borrow as much or as little as you like up to your agreed limit and can pay it back without incurring an early repayment fee.
However, they are a very expensive way to borrow long-term, particularly if your bank charges a daily or monthly fee as well as debit interest. An unsecured personal loan is more suitable for long-term borrowing.
How much overdraft can I get?
Overdraft limits are usually set when you first apply to open an account, based on your individual financial circumstances.
Occasionally, banks will offer an automatic overdraft but generally, they will consider your monthly incomings and outgoings, your credit score and employment status before deciding how much they are willing to offer you.
Your bank may agree to extend your overdraft limit at a later date, either temporarily or permanently. But all banks can reduce or cancel an overdraft at any time.
Does an overdraft affect my credit score?
Overdrafts show up on your credit report.
However, lenders treat overdrafts in different ways when deciding whether to lend to you.
If you’re applying for a mortgage, lenders will ask to see your bank statements (typically your last three months' worth).
Using an arranged overdraft sparingly shouldn’t cause any problems, unless you have applied for more finance or demonstrated poor money management in other ways.
But, living in your overdraft from month to month or having missed payments could scupper your chances.
Can I switch banks if I'm in my overdraft?
Being overdrawn shouldn’t stop you from switching to a new account – it should encourage you to shop around because overdraft users are more likely to gain from switching than other customers.
When you switch using the seven-day Current Account Switching Service (CASS), your overdraft can be transferred over, although your new bank may not match the overdraft limit you had before.
If you can’t move the old overdraft over to the new account, you will need to repay some, or all, of the existing overdraft before you switch.
Can I get an overdraft with a joint bank account?
Most joint bank accounts are run on an ‘either-to-sign’ basis where all parties can authorise transactions and make decisions independently.
Crucially, this means anyone can increase or decrease an overdraft. And, each person is responsible for the overdraft, even if they didn’t run up the debt.
Banks can even transfer money from any other accounts you hold with them to cover the debt on your joint account (though not the other way around).
How do I pay off my overdraft?
- Ask your bank to extend your arranged overdraft or waive the fees to give you some breathing space.
- Use mobile and online banking to check your balance regularly and keep an eye on outgoings.
- Sign up for text alerts to warn you when you’re approaching your overdraft limit to help you avoid charges.
- Change payment dates to make sure standing orders and direct debits leave your account at the right time, ideally shortly after you get paid.
- Switch to a cheaper bank offering an interest-free overdraft or lower overdraft charges.
- Shift the debt to a 0% credit card if you have a large overdraft that you can't pay off quickly. Read our guide to learn the golden rules for transfers.
- Open a basic account with no overdraft facility if you think this will help you manage your money better.
Find out more in our guide to how to deal with debt