⚡ Quick Answer
An overdraft is a short-term credit facility attached to your current account allowing you to spend more than your balance. Arranged overdrafts (agreed in advance) are more expensive than they look: typical rates are 19-40% EAR. Interest is charged daily only on the amount you’ve actually borrowed. Overdrafts work best as genuine short-term buffers (a few days between pay-dates). They’re expensive for anything sustained — a persistent £500 overdraft at 39.9% EAR costs about £54/year in interest, but longer-term reliance on overdrafts typically indicates a cashflow problem that a budget review would address better.
Overdrafts sit in a strange position in personal finance: widely used, often misunderstood, and frequently more expensive than people realise. Understanding exactly how the interest works — and when an overdraft (OD) actually makes financial sense versus when it’s a sign of a problem — is genuinely useful.
How Overdraft Interest Is Charged
Following FCA rule changes in 2020, all OD interest must be expressed as an annual EAR (Effective Annual Rate), with no daily or monthly fixed fees. This made OD costs easier to compare but didn’t make them cheaper.
Interest is charged on the actual daily balance — only on the amount you’ve borrowed, only for the days you’re overdrawn. At 39.9% EAR (a typical high-street rate):
- Borrowing £200 for 10 days: approximately £2.19 in interest
- Borrowing £500 for 30 days: approximately £16.43 in interest
- Borrowing £1,000 for 90 days: approximately £98.60 in interest
Short-duration, small-amount use is not catastrophically expensive. Long-duration or large-amount use is.
Arranged vs Unarranged Overdrafts
Arranged overdraft: agreed in advance with the bank, up to a set limit, at a known EAR. The standard way to use an overdraft.
Unarranged overdraft: going below zero without a pre-agreed facility, or exceeding your arranged limit. Since 2020, banks charge the same EAR as arranged overdrafts — the old punitive daily charges were banned. However, repeated unarranged OD use is damaging to your credit file and may result in the bank closing your account.
When an Overdraft Makes Sense
Genuine short-term timing mismatches — for example, a major bill falls due 4 days before payday and your emergency fund is genuinely not appropriate for this (it’s for real emergencies, not predictable cashflow gaps). A few days’ overdraft use costs very little in absolute terms.
When it’s not a good use:
- Running a persistent month-end OD — this isn’t a timing issue; it’s a spending-exceeds-income issue
- Treating the OD limit as available spending money rather than a safety net
- Using OD instead of an emergency fund — overdraft interest compounds; your emergency fund sits ready at no cost
If you regularly end up in your OD, the underlying issue is almost always cashflow — our guide on creating a monthly budget addresses the root cause more effectively than managing the overdraft itself.
Frequently Asked Questions
Does using an arranged overdraft affect my credit score?
Light use within an arranged limit has minimal credit score impact. Heavy, persistent use signals financial stress to lenders reviewing your file. Unarranged OD use is more damaging. Multiple declined transactions due to insufficient funds also appear in bank data.
Is there a 0% overdraft buffer anywhere?
First Direct offers a £250 interest-free OD buffer on its 1st Account — one of the few remaining examples after the FCA reforms removed most free OD buffers. Student current accounts from major banks also typically include interest-free overdrafts up to a set limit.
For current overdraft rates and comparisons, Which?’s overdraft comparison is regularly updated.
