Is Using Your Overdraft Just As Bad As Taking Out A Payday Loan? by Jessica Foreman

Thursday, 25 May 2017
For many of us, our overdraft is something that is a necessary part of the way we manage our money. A study found that more than a quarter of Brits – 27 per cent – are overdrawn by the 17th day after payday. The same study found that more than a third of people drop into their overdraft at some point during a month, while one per cent of people actually spend their entire month overdrawn.

Overdrafts, therefore, are commonly used. But are they commonly understood? Are they a smart way of managing your finances each month or are they as bad as taking out a short-term loan to foot an unexpected bill?

Call for a fees crackdown

The question has risen to the fore after a House of Lords report warned that action was needed to curb the fees paid by people using their overdraft.

Members of the Lords financial exclusion committee said that the poorest people in the country are forced to enter into the most expensive forms of borrowing.

It said that the limits recently placed on payday lenders have forced them to clean up their act – and called for similar measures to be extended to the rules surrounding overdrafts.

The committee said that we have now reached a stage in which borrowers needing £100 might pay back £156 more to their bank than they would a payday lender – making overdrafts a very expensive option.

Baroness Tyler of Enfield, chairman of the House of Lords financial exclusion committee, said: "The UK financial services sector is a world leader, which makes it doubly unacceptable that it is failing those who need it most."

"The 'poverty premium' - where the poor pay more for a range of services from heating their home to accessing credit - contributes to a vicious circle driving people ever deeper into debt and distress."

The committee called for a drive to improve the nation's 'financial literacy' – urging for primary school children to be taught more about managing their money to help them later in life.

Authorised and unauthorised

The committee paints a fairly bleak picture when it comes to overdrafts, but it'd be wrong to label them as a wholly bad option.

The financial literacy point is an interesting one and might well be key. The smart and sensible use of overdrafts can be a short-term, emergency credit option.

It's important to distinguish between different types of overdraft.

As this guide demonstrates, there are authorised and unauthorised overdrafts. Authorised overdrafts are the agreed 'limits' that you can borrow over and above your account balance. These are agreed with the bank and although they may carry fees, they might also have a small element (£100-£300) that carries no interest.

Unauthorised overdrafts, on the other hand, are not planned and involve you over-reaching your spending limit without prior warning to the bank. This tends to incur bigger fees – sometimes daily payments with extra charges for every transaction you make.

Being open with your bank and planning ahead can, therefore, save you from much of the worst of the fees and charges.

While the Lords committee has highlighted that more could and should be done, it's unfair to say that a carefully budgeted and modest use of your overdraft is worse than taking out a payday loan. Regular unauthorised overdraft use would, however, not be a wise move.

Jessica Foreman is a Durham University graduate specialising in business and lifestyle based writing. She has developed her skills on projects surrounding The British Broadcasting Company, and running a print and online based magazine whilst at university. She is currently looking towards starting her Masters in Mobile and Personal Communications as well as broadening her horizons through travelling.