When your account balance drops below zero, but the bank still approves a payment, that's insufficient funds in action. The bank essentially lets you borrow money, which you’ll need to repay, often with interest.
Overdrafts can be:
- Arranged (Authorised): Agreed in advance with your bank.
- Unarranged (Unauthorised): Not pre-approved; fees and penalties are higher.
Repayment methods vary. Some banks deduct the owed amount when your salary or deposit hits the account. Others may apply a monthly repayment schedule, especially for larger transactions.
What is an Overdraft Account?
An overdraft account is a bank account—usually a current one—with an agreed insufficient funds facility. Depending on your financial profile, the bank assigns a limit you can go over.
To be eligible:
- You typically need to pass a credit check
- The bank considers your income, payment history, and credit score
- It’s often used for covering short-term expenses, like bills or last-minute purchases
Types of Overdrafts: Arranged vs. Unarranged
- Arranged Overdraft: Pre-approved with a specific limit, like £500 or €500. Comes with set interest rates and predictable fees.
- Unarranged Overdraft: No prior agreement. Higher charges, possible declined payments, and negative effects on your credit score.
What is an Arranged Overdraft Limit?
An arranged overdraft limit is the maximum amount your bank allows you to borrow once your account hits zero. It’s determined based on:
- Your credit history
- Income level
- Existing debts
- Overall banking activity
Some banks with overdraft offer online calculators to estimate your likely limit.
Overdraft Fees and Charges
Both arranged and unarranged overdrafts come with costs:
- Interest charges
- Daily or monthly fees
- One-off charges for exceeding your limit
The exact fees vary by bank. Some offer fee-free buffers (e.g., the first £50 or €50), while others apply tiered interest based on the amount you owe.
How Much Does an Overdraft Cost?
Example:
- Arranged overdraft: 39.9% APR
- If you use £100 or €100 for 15 days, it might cost around 1.65 in the respective currency
- Unarranged: Higher rates, plus one-time fees (5–20 GBP or EUR per event)
How Are Overdraft Fees Calculated?
Fees are based on:
- The amount borrowed
- Duration the account stays in overdraft
- Whether the overdraft is arranged or not
Most banks calculate interest daily and charge monthly. Unarranged overdrafts may also trigger returned payment fees.
Does an Overdraft Affect Your Credit Score?
Yes, it can. Here's how:
- Arranged overdrafts reported to bureaus as a form of credit
- Consistently maxing out your overdraft may hurt your score
- Late repayments or going over your limit could have a negative effect
Good management can improve your credit profile, but poor use may signal financial strain.