Overdraft Borrowing Cost Summary
An overdraft allows UK current account holders to borrow money directly through their bank account when their balance drops below £0. Following landmark FCA overdraft reforms, banks are legally banned from charging flat daily or monthly overdraft fees or charging higher rates for unarranged borrowing compared to arranged borrowing.
Instead, all UK banks must quote a single Effective Annual Rate (EAR) interest percentage for both arranged and unarranged overdraft borrowing. High-street banks typically set overdraft EAR interest rates around 35% to 40% EAR, making overdrafts one of the most expensive short-term credit forms in the UK.
⚙️ Rules & Thresholds
- Single EAR Rule: Banks must charge a single interest rate (EAR %) for overdrafts; flat daily/monthly fees (e.g. £1/day) are banned.
- Equal Pricing: Unarranged overdraft interest rates cannot exceed arranged overdraft interest rates.
- Interest-Free Buffers: Some premium or student bank accounts offer small fee-free overdraft buffers (e.g. £25, £50, or up to £1,000 for verified full-time students).
- Daily Calculation: Overdraft interest is calculated daily on the end-of-day overdrawn balance and typically debited from the account once per month.
📊 Practical Examples
- Overdraft Used: £500
- Fee-Free Buffer: £50
- Chargeable Overdrawn Balance: £450 (£500 - £50)
- Bank Overdraft Rate: 39.9% EAR
- Days Overdrawn: 15 Days
Compounded Daily Interest Rate: ~0.0921% / day
Daily Overdraft Cost: £0.41 / day
Total Monthly Overdraft Charge (15 days): £6.22
📑 Common Pitfalls
- Using Overdrafts as Long-Term Debt: With typical EAR rates between 35% and 40%, keeping a balance of £1,000 in an overdraft for a full year costs around £350–£400 in interest alone!
- Exceeding Fee-Free Buffers: Assuming your entire overdraft is interest-free when only the first £50 or £100 is covered leads to unexpected monthly charges.
- Ignoring Credit File Impact: Consistently operating near your maximum overdraft limit can negatively impact your credit score, making future mortgage or personal loan applications harder.
❓ Frequently Asked Questions (FAQ)
The Effective Annual Rate (EAR) is the interest rate charged on an overdraft taking into account how frequently interest is charged and compounded (usually daily). EAR shows the true annual cost of borrowing if you remain in your overdraft for a full year without making repayments.
An arranged overdraft is a pre-agreed borrowing limit set up between you and your bank. An unarranged overdraft occurs when you spend more money than you have in your account without prior agreement, or exceed your arranged limit. Under FCA rules, banks cannot charge higher interest rates for unarranged overdrafts than arranged ones.
To clear an overdraft quickly, create a strict monthly budget, transfer the balance to a 0% money transfer credit card (or lower-cost personal loan), or use cash reserves to clear the balance. Because overdraft interest is charged daily, making small frequent repayments immediately reduces your daily interest costs.
Yes. Overdrafts are repayable on demand under UK banking regulations. A bank has the legal right to reduce your overdraft limit or ask for full repayment at any time, although banks are expected under FCA Conduct of Business rules to treat customers in financial difficulty fairly.