Overdrafts are a form of debt, they allow you to borrow money through your current account. These should be used for short-term borrowing or emergencies only. Your bank, with your own agreement, should be able to provide you one on your checking account.

You can also apply for overdrafts, as long as you meet certain specific requirements. For example, international students, who open a student account, can't apply for an overdraft facility.

There are currently two types of overdrafts.

Authorised overdrafts

These are arranged in advance. You have usually requested them or your bank has offered you one, when you opened your account. In this case, you agree to a borrowing limit and you can spend up to that amount.

If you have a pre-arranged overdraft of £1,000, your spending power is equal to the money in your account plus the overdraft. You can use all the normal payment methods with no problem.

The fee for using your authorised overdraft may vary from bank to bank. There are different types and they may also depend on how much you are overdrawn. You can also find some bank with a limited interest-free overdraft.

The overdraft charge might be made up of:

• Interest, which can be up to 15-20% equivalent annual rate (EAR).
• A daily (50p-£3 a day), weekly or monthly fee.

Unauthorised overdrafts

These overdrafts happen in two scenarios. When you spend more than your pre-arranged overdraft or the money you have left in the bank. If you find yourself in an unauthorised overdraft, you will pay fees and they can grow very quickly.

The unauthorised overdrafts charge can come in many forms.

• Daily fee: can be £1 to £6 a day or more.
• Monthly fee: anything from £5 to £35 or more.
• Transaction fees: can be £10 to £25 for every cash withdrawal, Direct Debit or standing order, cheque or card payment you make – whether or not your bank allows the payment.

As of November 2017, Lloyds, Halifax and Bank of Scotland are removing these completely. Customers will switch to a flat rate of 1p a day per £7 borrowed on arranged overdrafts. This is a huge step forward, but will also affect those who use more than a £700 overdraft facility. The charges will increase for them.

In the case of Halifax, clients were paying £1 a day for their overdraft up to £2k. With the new rules, if you are £750 overdrawn, you will end up paying £700 / £7 * £0.01 per day, which is equal to £1.07. This number increases with the overdraft.

Although this sounds a bit terrifying for certain consumers, the new approach is much simpler and has completely removed unauthorised overdrafts forever. Groups such as Halifax were charging £5/day with the risk of putting you in a never ending spiral of debt.

If you are looking for a way to clear your overdraft, read our previous post.