An arranged overdraft allows the balance of your bank account to dip below £0 and 'into the red' as it's often called. It acts as a safety net for unexpected expenses and to tide you over for (usually) a short period of time. There are two types of overdraft: arranged and unarranged.
If you think you'll dip into the red from time to time, it's worth applying for an arranged overdraft before this actually happens.
While it may be tempting to use your arranged overdraft as a continuous spending limit, it will have to be repaid at some point, so be careful not to borrow more than you can pay back.
Ongoing overdraft usage (day in-day-out and over a continued period of time) is referred to as 'hardcore' usage, and hardcore usage may reduce your overall credit score by indicating to the bank that you are reliant on this buffer amount, to the point where you simply cannot manage your finances without it.
There is a massive difference between an arranged overdraft - a limit you agree in advance with your bank - and an unarranged one, as aforementioned.
Arranged overdrafts may (or may not) cost anything to use - that all depends on your bank - although it's highly unlikely you'll get to dip into overdraft funds without incurring some sort of cost, whether it's a daily rate of interest that's applied for every day you go overdrawn, or a flat fee for having the facility to begin with.
Unarranged overdrafts will almost always attract penalty fees, and those fees can come in the form of a flat fee, for example, a £15.00 fee for every rejected direct debit, plus a calculation of interest that may be charged until your account is brought back into credit.
An overdraft may be suitable if you:
- Need help with cash flow but do not depend on it constantly
- Have an irregular income. For example, if you’re self-employed and have difficulty in predicting when money hits your account
- Need to make regular payments from your account before your wages are paid in
- You need a sum of money to pay for something before you get paid
In other circumstances, though, you might be better off borrowing money a different way.
Credit cards are another borrowing option, as well as overdrafts and loans. They allow you to make purchases and repay the money when the bill comes in. Be mindful, though, that if you don't pay off your bill in full, you will be charged interest, which could be costly.
How a credit cards works is that you will be given a spending limit that's referred to as a 'credit limit'. You won’t be able to spend more than this limit on your card, which is a good thing as it can minimise your debt and contribute to responsible lending.
A credit card may be suitable for you if:
- You want the flexibility to buy something now but pay for it later
- You can afford to clear your statement balance each month
- You spend at a date that allows you to maximise up to 56 days interest free credit
- You like the idea of having protection under Section 75 of the Consumer Credit Act
It may not be suitable for you if:
- You can only make the minimum payment, which will take you longer to pay your bill and cost you more in interest
- You are looking for a method of repayment with fixed payments and require some structure so that you can budget
With a personal loan you can borrow a sum of money and agree to pay it back over a fixed period of time, usually at a fixed rate of interest, although sometimes the interest may be variable.
A personal loan may be suitable for you if:
- You want to make a large purchase and don't have all or some of the cash to hand
- You want to budget and have the peace of mind of making regular repayments, usually on the same date each month
- You like the transparency of understanding the total amount payable across the entire loan term
It may not be suitable if:
- You only have a short term or temporary borrowing need
- You don’t have a guaranteed income every month
- You have a low credit rating and/or poor historical repayment history
Your credit rating
A lender will use your credit rating to decide whether they can lend you money, how much they are willing to lend you and the interest rate they will charge.
Having a good credit rating will increase your chances of being approved when applying for a credit card, personal loan or a mortgage
What has a positive effect on your credit rating?
- Being on the electoral register at your current address
- Paying your bills on time – this includes everything from your credit card to your household electricity and your mobile phone bills
- Showing you’re in control of your borrowing – regardless of how much you earn