Overdraft? Under control?

Overdraft? Under Control?

Back in 2011 I was interviewed for a local paper for a piece on affordable credit. It was around the time when community credit unions were becoming more widely known about and it seemed a good way to promote the services we offered.

After the usual questions the journalist put her pen down and rather sheepishly mentioned her own £1500 overdraft, “How much” she asked “would a loan for the same amount be?”

I did some quick calculations and told her that a loan over eighteen months would be around £100 per month. She was horrified “But my overdraft only costs me £35 a month!”

I tried to explain to her that the credit union loan was for a fixed term, at a fixed rate of interest and with fixed terms and conditions, whereas, if she never tackled the balance, her overdraft would continue to cost her at least £35 per month indefinitely. She wasn’t having any of it!

We parted company, leaving me with the realisation that, on the whole, for those who have one, overdrafts no longer register in their consciousness as a debt.

Long term debt & short term costs

Fast forward to December 2017 and the level of indebtedness caused by overdrafts is well on the radar of the Financial Conduct Authority and the feature of a report publish by debt charity Step Change. Understandably so, an estimated 13 million account holders went into overdraft during the last twelve months.

Because overdrafts are considered short term borrowing, there is a tendency to think about them in a ‘short-term’ way. The charges are calculated monthly, so borrowers are lulled into thinking of charges one month at a time – except for the over two million people in the UK who are permanently in the red. If the journalist has had the same overdraft on the same terms since 2011, it will have cost her over £2500 in fees, and she’ll still owe £1500.

Overdrafts are a significant source of revenue for banks. They recognise that the general public’s perception of what they should pay for credit has resulted in a dangerous anomaly where a personal loan of £1500 with an APR of around 25% will seem extortionate while the ongoing charges for an overdraft will appear quite reasonable.

Charges on Charges?

The other overdraft minefield is that banks have the right (with notice) to vary the terms, amount, fees and costs. Last month Halifax and Lloyds brought in a new flat fee of 1p a day for every £7 that someone borrows over their fee-free limit. It doesn’t sound much but with the average overdraft running to £1700 this can prove an untenable burden on already stretched household finances.

One of our members approachedChurches Mutual for assistance when their £5000 overdraft resulted in charges of over £200 per month, charges that were themselves incurring charges. The overdraft had grown steadily over a number of years with the co-operation of the bank who had now moved the goal posts, and the member needed to reduce their overheads by£200 per month just to stand still. The bank has admitted that its new charges are equivalent to an APR of 52% while a loan for the same amount is advertised at 9.9% APR. No surprise then that banks find overdrafts an attractive product. Fortunately our member was able to clear his overdraft with a Payroll Savers Loan, with repayments at £150 per month saving £50 and reducing the balance in a manageable way.

Halifax and Lloyds have said that the new charging scheme benefits 80% of their customers which leaves 20% out of pocket, and where they lead other banks could well follow. Banks only have to give 30 days’ notice to change terms and conditions, which isn’t long to make alternative arrangements when this happens. If the experience of our member is ringing alarm bells in your head, perhaps answering the following questions may help you decide that 2018 is the year to go overdraft free.

Seven hard questions for overdraft users

  1. How long have I had this ‘short-term’ loan?
  2. How many times has the limit increased?
  3. Did I ask for that or did the bank just do it?
  4. How much did my overdraft cost me in fees and charges in 2017?
  5. Could I afford to pay 1p for every £7 per overdrawn day?
  6. If the bank cut my overdraft at 30 days’ notice could I cope?
  7. Would a loan with a clear start and finish date and a fixed APR be a better option?