Overdraft Loans

Find out how overdrafts work, their impact on loans, and whether it's better to pay off your overdraft with a loan.

Table of contents

Written by Mark Grimley
Read time: ~5 mins
Published: 28th September 2023

Is an Overdraft a Loan?

No, an overdraft is not a loan in the traditional sense. It's more like a pre-arranged credit facility provided by your bank. It allows you to withdraw more money than what is available in your account, up to an agreed limit. Think of it as a safety net for those times when unexpected expenses arise, or you're waiting for your next paycheck.

Does Having an Overdraft Affect Getting a Loan?

Having an overdraft, whether arranged or unarranged, can potentially impact your ability to get a loan. When you apply for a loan, lenders assess your creditworthiness, which includes factors such as your income, credit history, and existing debts. If you have a large overdraft or consistently rely on overdrafts, it may raise concerns for lenders. They might question your ability to manage additional debt responsibly.

Is It Cheaper to Get a Loan or an Overdraft?

The cost of a loan or an overdraft can vary depending on several factors, including the amount borrowed, the duration of borrowing, and the interest rates charged by lenders. In general, if you need a larger sum of money over a longer period, a loan may offer a more cost-effective solution. On the other hand, an overdraft is typically suitable for short-term borrowing needs or occasional financial flexibility.

Should I Get a Loan to Pay Off My Overdraft?

This is a decision that requires careful consideration. While taking out a loan to pay off your overdraft might seem like a good idea, it's important to assess your financial situation thoroughly. Consider the interest rates, repayment terms, and any potential fees associated with both the loan and your overdraft. It's advisable to compare available options and seek professional advice if needed.

What is an Overdraft?

An overdraft is a financial arrangement offered by your bank that allows you to spend more money than what is available in your account. It's like a financial cushion that bridges the gap between your expenses and your available funds. With an overdraft, you can cover unexpected bills, make essential purchases, or handle temporary cash flow issues without facing rejection or penalty charges.

How Do Overdrafts Work?

Overdrafts work by giving you access to additional funds when your account balance reaches zero or goes negative. There are two types of overdrafts: unarranged and arranged.

  • Unarranged Overdrafts: If you spend more money than what's available in your account without prior agreement with your bank, you enter an unarranged overdraft. This can result in high fees and charges, so it's essential to avoid using this type of overdraft unless absolutely necessary.
  • Arranged Overdrafts: An arranged overdraft is a pre-agreed borrowing limit set by your bank. You can spend up to this limit without incurring unarranged overdraft fees. However, interest may still be charged on the amount you borrow, and it's crucial to manage your borrowing responsibly.

Is It a Good Idea to Get an Overdraft?

An overdraft can be a useful financial tool when used wisely. It provides a safety net for unexpected expenses and short-term cash flow gaps. However, it's important to consider your financial circumstances, including your ability to repay the borrowed amount and any associated fees or interest. If you find yourself relying on your overdraft frequently or struggle to repay the borrowed funds, it may be worth exploring alternative options.

What Happens When You Use Your Overdraft?

When you overdraw your account, either through an unarranged or arranged overdraft, several things can happen:

  • Your bank may charge fees or interest on the borrowed amount.
  • Your bank may contact you to discuss your overdraft usage and offer guidance.
  • If you fail to repay the overdraft or resolve the negative balance, it can have a negative impact on your credit score and financial reputation.
  • Continued reliance on overdrafts can lead to financial instability and make it more challenging to access credit in the future.

How Do You Pay an Overdraft Back?

Repaying an overdraft depends on whether it's an arranged or unarranged overdraft:

  • Arranged Overdrafts: You can repay an arranged overdraft by making regular deposits into your account and reducing the negative balance over time. It's important to check with your bank for their specific repayment policies and options.
  • Unarranged Overdrafts: If you enter an unarranged overdraft, it's crucial to bring your account back to a positive balance as soon as possible. Contact your bank to discuss repayment options and strategies.

Is Using an Overdraft Bad for Your Credit Score?

Using an overdraft responsibly and within agreed limits generally does not directly impact your credit score. However, excessive or persistent reliance on overdrafts, especially unarranged overdrafts, can negatively affect your creditworthiness. Lenders may view it as an indicator of financial instability or poor money management skills, potentially making it more challenging to access credit in the future.

How Long Do You Have to Pay an Overdraft Back?

The repayment period for an overdraft depends on the terms and conditions set by your bank. Typically, an arranged overdraft remains available as long as you continue to meet the required criteria. It's important to manage your overdraft responsibly and aim to reduce the negative balance as soon as possible to avoid accumulating unnecessary fees and charges.

What Are the Pros and Cons of Overdrafts?

Let's take a look at the pros and cons of overdrafts to help you weigh your options:

  • Quick access to funds in emergencies or unexpected expenses.
  • Provides a safety net when you're waiting for your next paycheck.
  • Offers flexibility for short-term borrowing needs.
  • May help you avoid expensive payday loans or high-interest credit cards.
  • Can lead to fees and charges, especially with unarranged overdrafts.
  • Continued reliance on overdrafts can indicate financial instability.
  • Overuse of overdrafts may negatively impact your creditworthiness.
  • Interest charges can accumulate over time if the overdraft is not repaid promptly.

Frequently Asked Questions

Can I apply for an overdraft?

Overdrafts are usually provided by your bank as an additional feature of your current account. Contact your bank to inquire about their overdraft application process.

How is bank OD interest calculated?

Bank OD interest is calculated based on the amount of money you borrow from your overdraft and the interest rate set by your bank. It's important to check with your bank for the specific details on how interest is calculated and charged.

Can I use an overdraft for everyday expenses?

While an overdraft can provide temporary financial assistance for everyday expenses, it's important to use it responsibly and not rely on it as a long-term solution. Regularly overdrawing your account can lead to fees and charges, as well as potential financial instability.

Are overdrafts only available for current accounts?

Overdrafts are commonly offered as an additional feature of current accounts. However, it's best to check with your bank to see if they offer overdraft facilities for other types of accounts, such as savings or student accounts.

Can I switch banks if I have an existing overdraft?

Yes, you can switch banks even if you have an existing overdraft. However, it's important to consider the terms and conditions of your current overdraft and how it will be affected during the switching process. Contact both your current and potential new bank for guidance on how to proceed.

Can I have multiple overdrafts?

It's generally not recommended to have multiple overdrafts. It can be challenging to manage multiple accounts and their associated overdrafts, leading to potential financial difficulties. It's advisable to focus on responsibly managing one overdraft, if needed, and exploring alternative financial options.

Can I increase my overdraft limit?

Depending on your bank's policies and your financial circumstances, you may be able to request an increase in your overdraft limit. However, the bank will assess your creditworthiness and may require additional information before approving any changes to your limit.

Can I cancel my overdraft?

You can request to cancel your overdraft by contacting your bank. However, it's important to consider your financial situation and whether you have alternative sources of credit or emergency funds before cancelling your overdraft. Speak with your bank for guidance on the process and any potential implications.

What happens if I can't repay my overdraft?

If you're struggling to repay your overdraft, it's important to contact your bank as soon as possible. They may be able to offer assistance or discuss alternative repayment options. Ignoring the situation can lead to further financial difficulties and potentially affect your credit score.

Written by
Mark Grimley
Head of Partnerships & Take Control Author at Choose Wisely

Mark joined Choose Wisely in 2015. He continues to work in close contact with the providers, brokers and journalists operating in the world of consumer credit.

Important Information.

All of the information in this guide is correct at the time of writing.

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