Low overdraft fee accounts enable us to minimise our monthly overdraft fees.
Why get low overdraft fees?
Overdrafts aren’t necessarily the best way to borrow money for the longer term. In fact, if used badly, overdrafts can be one of the most expensive forms of loan available.
Ideally, if you need to borrow money, you should seek out cheaper forms of credit (money transfer cards, personal loans etc.) before using an overdraft. However, we don’t live in an ideal world, and many people still use their overdraft every month to 'get by', seeing it as the least bad option. So, if using an overdraft is a financial necessity, how can you minimise the cost of such borrowing? And how can you protect yourself if you unexpectedly need short-term credit?
How are overdrafts charged?
In the UK, overdrafts fees tend to be structured in one of two ways.
Historically, all overdrafts were charged as a rate of interest and expressed as an EAR (equivalent annual rate). EAR is very similar to the more commonly used APR (annual percentage rate), which is used to show the cost of borrowing over a single year on a fixed debt, including any charges (as with personal loans). But, while APR applies to products that are only designed for borrowing, EAR indicates that the product might (and ideally should be) in credit.
So for example, if you maintained a £500 overdraft for one year (you didn't repay anything), and your EAR interest was 20%, you'd pay £100 in interest per year - (£16.66 per month/54p per day).
After criticism from regulators (that overdraft charges were opaque), some UK banks moved to introduce daily fees to increase transparency.
Typically, daily overdraft fees are charged on a tiered structure, linked to the overdraft amount. (eg. £1 for overdrafts up to £1,000, £2 for overdrafts up to £2,000, or £3 for overdrafts over £2,000).
The aim of daily overdraft fees was commendable, yet they are not without critics. For instance, the difference between an overdraft of £1000 and £1001, based on the structure above, would be £31 (a 100% increase in charges for an additional £1 borrowing).
It is also the case that fee-based overdraft charges tend to be higher than interest-based charges. For example, to incur the same £365 in charges that a £1,000 overdraft on daily charges of £1 would, an EAR would need to be 36.5%, a rate higher than many bad credit credit cards. Furthermore, this example does not account for the fact that by month 2 of the daily charge structure, you will have moved into a higher tiered rate.
Finally, although daily fees are arguably more transparent, they can also encourage people to increase their debt levels, since it may have no effect on their monthly charge - borrowing £500 per month might cost the same as £999 (£1 per day). Obviously, in the short-term (for emergencies), that might be useful, but the debt will ultimately need to be repaid, so increasing it is only likely to result in additional charges.
Minimising your overdraft fees
The criticisms of daily charges described above could prove to be a key motivator in ensuring that you don't get into debt, which is always preferable.
However, if you tend to be reliant on your overdraft month on month, you should always look to minimise what you pay by choosing an EAR based charging structure, rather than a daily fee tier. Or, even better, you should find a cheaper alternative source of credit for long-term debt, and avoid using your overdraft unless absolutely necessary. This will then mean you can focus your current account switching on obtaining features that will offer tangible benefits to your life, rather than simply the best overdraft rate.
Can I switch current accounts while I have an overdraft?
Assuming you are approved for an overdraft (they are always subject to a credit and status check), then yes. Overdraft charges are one of the main methods banks use to make money, and your new bank will be very happy to make money from you.