What is an overdraft and how does it work?

Quick answer: An overdraft lets you borrow money through your bank account when your balance goes below £0. Used carefully, it can be a safety net to cover unexpected payments. But overdrafts often have high rates, so they’re not right for long-term borrowing. Always try to arrange an overdraft before using one.

Overdrafts are a way to borrow money through your bank, which can help cover payments if you run out of money in your current account. But overdrafts can quickly become expensive, and some people end up relying on them. It’s also possible to go into an overdraft without meaning to.

Our guide covers how overdrafts work, like when you’re charged interest and how to pay it off. We also explain the important differences between arranged and unarranged overdrafts. Read on to learn if an overdraft is right for you.

What is an arranged overdraft?

An arranged overdraft is when your bank agrees you can spend more money than you have in your current account, up to a set limit. For example, if you have a £200 overdraft and your bank balance reaches £0, you can spend up to £200 more through your bank account. You’ll pay interest on the amount you borrow until you pay it back.

An arranged overdraft might help you if urgent or unexpected costs come up. But they can be an expensive way to borrow, especially in the long term.

What is an unarranged overdraft?

An unarranged overdraft may happen if you spend more money than you have in your bank account, without agreeing an overdraft with your bank first. It can also happen if you have an arranged overdraft and go over your limit.

It’s possible to use an unarranged overdraft without meaning to — for example, if you forget about a bill or have less money than expected. Depending on the situation, your bank may try to decline a payment instead of opening an unarranged overdraft.

Is it bad to go into an unarranged overdraft?

Going into an unarranged overdraft has several downsides, like:

• Your bank will usually charge interest on what you owe, which can be expensive.
• Some banks won’t let you make transfers, payments or withdrawals until you pay back the overdraft.
• An unarranged overdraft may lower your credit score, which can make it harder to get credit in the future.
• Your bank may default your account, especially if you use an unarranged overdraft often. If you don’t repay them within the default notice period, they may file a county court judgment.

How does an overdraft work?

If you’ve arranged an overdraft with your bank, you can start borrowing from it when your bank balance goes down to £0. There’s usually no need to do anything extra. Just spend on your debit card, withdraw cash or make transfers like usual.

Your overdraft has a limit, which is the total amount you can borrow. You don’t have to borrow it all. If you go over your limit, you’ll go into an unarranged overdraft.

Going into your overdraft is called being overdrawn. Your bank statement will show how much you’re overdrawn by and how much more you can borrow. For example, if you have £100 in your account and an overdraft limit of £1,000, and you spend £300, your statement should show an account balance of -£200 and an available balance of £800. This means you owe £200 and can borrow a further £800.

You’ll usually pay interest on the amount you owe at the rate your bank gave you. Overdrafts don’t tend to have fixed payments, but paying it as soon as possible can help you keep interest costs down.

How do overdraft fees work?

Overdraft fees and additional charges haven’t been allowed in the UK since April 2020, no matter whether your overdraft is arranged or unarranged. UK banks can only charge a simple annual interest rate for overdrafts.

How does overdraft interest work?

You’ll only be charged interest when you’re overdrawn. Interest is calculated as a percentage of the amount you owe. This percentage is called the rate. The rate you actually get may be higher or lower, depending on how lenders see you.

Your credit score can give you an idea of how lenders are likely to see you. The higher your score, the more chance of getting some of the top rates.

Overdraft interest is usually calculated daily and the charge added to your balance monthly. This means your balance can grow even if you don’t borrow more. You’ll be charged interest on the total balance, including on any interest you already owe.

Some banks may not charge interest if you only borrow a bit. For example, the first £25 of your overdraft may be interest-free. Some banks offer 0% interest on student overdrafts, although your rate usually goes up when you graduate.

How much does an overdraft cost?

The cost of an overdraft depends on things like your Effective Annual Rate (EAR), how much you borrow and when you pay it back.

The table below shows how much interest you might pay if you stayed overdrawn by the same amount for a full year at different interest rates. You would have to pay back this interest, as well as the amount you’d borrowed.

Amount overdrawn	22% EAR	40% EAR	50% EAR
£100 overdrawn	£22	£40	£50
£500 overdrawn	£110	£200	£250
£1,000 overdrawn	£220	£400	£500

These examples are based on a fixed amount of borrowing. People often dip into their overdraft and pay some of it back at different points in the year. That means the actual amount of interest could be lower or higher than these examples.

How do I get an overdraft?

If you think it’d be a good idea for you to get an overdraft, it’s best to arrange one instead of going into an unarranged overdraft. Contact your bank to arrange an overdraft. You can usually apply for an overdraft online, by phone or in a branch. If you’re approved, the bank sets an overdraft limit and interest rate.

Getting an overdraft with your current bank may be simpler, as they should already have some information about you. But other banks may have better deals. Some banks let you apply for a current account and overdraft at the same time. If you switch banks, the Current Account Switch Service can help you move your payments and direct debits.

How much overdraft can I get?

How much overdraft you can get depends on the bank and whether you meet their criteria. When you apply for an overdraft, the bank may run a hard credit check and ask for information about things like your income and employment. This helps them decide whether to approve you, as well as the rate and limit that you’d get. Overdraft limits are often lower than what you may be able to get with credit cards and loans.

How does an overdraft get paid back?

If you’re overdrawn, any money coming into your account, like wages, benefits or a bank transfer, goes towards paying off your overdraft.

If you want to lower the cost of interest, pay your overdraft as soon as possible. Interest charges stop when your balance returns to £0 or above. You may be able to set up alerts from your bank to warn you when your balance is low, which could help you avoid going into an overdraft.

What happens if I can’t pay my overdraft?

If you’re struggling to pay back overdraft debt, contact your bank and explain your situation. They may be able to help by pausing interest, lowering the rate or setting up a repayment plan.

You have a right to use payments into your account for essential costs, like food, rent and bills, before paying off your overdraft. Tell your bank if you need this. If you want more control over your income, you can also consider opening a basic account with a different bank to pay your income into.

You can make a complaint to your bank if they don’t treat you fairly, or to the Financial Ombudsman Service if the issue isn’t resolved. You can get free, independent debt advice from charities like StepChange and National Debtline.

How long do you have to pay an overdraft back?

It’s usually up to you, although overdrafts aren’t meant for long-term borrowing. If you want to avoid paying any interest, repay your overdraft the same day you go into it.

Your bank can decide to cancel or lower your overdraft limit at any time. This may be more likely if you keep going over your limit. Your bank must warn you if they’re going to do this.

If your bank sends you a default notice, you usually have two weeks to pay your overdraft back. If you can’t do this, contact your bank straight away to try and stop them from taking legal action. They might agree to a repayment schedule you can afford. Citizens Advice explains what to do in more detail.

How to manage an overdraft?

Managing an overdraft carefully can help you avoid interest charges and protect your credit score. Here are some tips for using it well:

• Arrange an overdraft with your bank instead of going into an unarranged one.
• Check the interest rate so you understand the cost of borrowing.
• Only use your overdraft for short-term borrowing, and only when you need it.
• Stay within your limit and pay back your overdraft as soon as you can.
• Check your credit score regularly to see if your overdraft affects it.

If your overdraft is becoming long-term debt, you may want to:

• Create a budget and try to find ways to pay off your debt.
• Ask your bank for support if you’re struggling to pay, like a break from interest.
• Get free debt advice from an organisation like StepChange or National Debtline.

Consumer Finance Expert

Our expert says

An overdraft can be useful for covering short-term money gaps. But it’s important to use it carefully. Stay within your agreed limit and pay your overdraft back quickly to help lower the cost of interest and protect your credit score. Jacqui Hamilton, Experian UK

Frequently asked questions

Do overdrafts affect credit score?

Yes, overdrafts can affect your credit score depending on how you use them. An overdraft shouldn’t harm your score if you use it responsibly — for example, by staying within your agreed limit and paying it off regularly. Your score may go down if you keep using an unarranged overdraft or your bank defaults your account.

What to do if you go into an unarranged overdraft by accident

Pay it off as soon as you can. Some banks won’t charge interest if you pay your overdraft on the same day. This also makes it less likely that an unarranged overdraft will be recorded on your credit report. If it is, you may be able to add a Notice of Correction to your report to tell lenders what happened.

Check your report and score free on the Experian app. Don’t worry, checking won’t affect your score.

Can banks charge me a fee for going into an unarranged overdraft?

No, but they can charge interest on the amount you owe. Before April 2020, UK banks often charged high fixed fees for an unarranged overdraft, and sometimes a fee for each payment made within it. They’re no longer allowed to do this.

Can my bank close my overdraft without telling me?

No, your bank must tell you if they’re going to cancel or reduce your overdraft. If they give you no warning, you may be able to make a complaint to the bank or the Financial Ombudsman Service.

Is an unarranged overdraft more expensive?

Banks aren’t allowed to charge a higher interest rate on unarranged overdrafts than on arranged overdrafts. It’s best to avoid an unarranged overdraft as it can lead to blocked transactions, a lower credit score and even a defaulted account. Also, overdraft interest rates are usually high and there may be cheaper ways for you to borrow.