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How to Calculate the Actual Cost of Your Overdraft

by Jim ONeil on January 12, 2011

in Personal Finance Tips

With so many banks today charging extra for using the overdraft facilities, it would be very important for you to find the actual cost of using an overdraft facility. While it may be very convenient, using your overdraft for just a couple of days will mean that you will have to pay heavy fees that will bring up the expense of borrowing quite significantly. Here is how you should calculate how much the overdraft is really costing you:

Work Out the Actual Cost

A majority of the overdraft facilities will charge a type of interest and fees when you use these services. Even the ones that offer interest free or fee free borrowing to a limit may levy very high interest charges when you exceed the limit. Knowing what interest rate you will exactly have to pay will mean that you will be able to make a conscious decision if using the overdraft is worthwhile or if there would be another cheaper alternative to borrow funds.

The lenders are required to mention all of their fees and interest rates on their overdraft very clearly in the account agreement or in their terms and conditions. This is what you must check first. This information would be easily available on the website of the bank or you can also contact the nearest branch. Check the paperwork to find out more about:

1.    The Overdraft Limit:

This would the maximum money that you would be able to withdraw from the current account. Knowing what your limit is would be very important so that you can remain within the limit and be sure regarding how much money you will be able to borrow without having to worry about a penalty. Any amount you borrow within the limit is known as the authorised borrowing and spending beyond the limit is known as unauthorised so you will be charged extra fees for it.

2. Interest Free Limit If Any:

A few current accounts will offer their clients a part of the overdraft facility as interest free. Usually this amount is between GBP 50 and GBP 250. When you calculate the expense of the overdraft, ensure that you research about whether you are eligible for an interest free drawing limit and what your free limit is. You would be then able to use it for the cost calculations.

3. Interest Rate for Your Authorised Borrowing:

Once you factor in the free limit you would also need to know about the interest rate that would be applied to the overdraft facility. The interest rate would be stated clearly in the terms and conditions. This information would be really useful when you want to compare the overdraft costs offered by different accounts.

4. Interest Rates for Your Unauthorised Borrowing:

The interest rate that would be applied to your unauthorised borrowing would be greater than what is charged for your authorised borrowing. If you exceed the limit you would be paying extra for the privileges and this is an extra cost that you must add to the calculations that you make.

5. Authorised Fees:

A large number of banks and lenders today charge fees when they use their overdraft facility. Quite often this would be marketed as a simple and clear amount. However, these fees are quite often charged over and above the interest rate that you would have to pay. Since these fees would significantly increase the expense of borrowing, you will have to learn if you will be charged fees for the overdraft and how much exactly you will need to pay. Some of the accounts would apply a fee every single day that you are overdrawn while some of the others may apply a fixed single fee.

6. Unauthorised Fees:

If you borrow over the limit assigned then you would soon be paying heavy fees along with the interest that you may already be paying. These are the expenses that have often being complained about to Financial Ombudsman in the last few years. For this reason quite a lot of banks have brought down the fees because of public pressure. The amount that you may have to pay may be quite high so you will have to find out exactly how much you will pay.

7. Annual Fees:

Quite a lot of accounts also have an annual fee over and above the interest rate that you normally pay when you borrow. The annual fee could be as packaged subscription for your account or an administration fee for your overdraft facility. It can be quite easy to overlook an annual charge but they do contribute for the overall cost of borrowing so you will have to consider it.

Calculating the Overall Cost

Now you would know the elements that together contribute towards your overall cost of overdraft. You may now start calculating the exact amount that you will have to pay for borrowing money on your
overdraft. The easiest way to go about it is by first deciding how regularly you utilize your overdraft. This can be done by taking a look at your earlier statements to see how often you used the services. Calculate an average of the last three months to get an idea about your borrowing habits.

Calculate how much money you spend on daily and monthly overdraft charges every month along with the amount you pay as unauthorised and authorised interest. After you have added up the charges, fees and interest that you incur every month you would get an idea about the actual cost of the overdraft. Unless this total cost is nearer to zero, there are chances to find cheaper borrowing means for your requirements.

Considering Other Options

If you think that using overdraft costs you a lot more money than what you had expected, there are several other alternatives that you may consider:

1.    Make a Budget

The easiest method to avoid paying any overdraft fees and charges is to make a budget so that you would know how much money you have with you for spending. Make a monthly budget and keep a tab on how much money you are earning and how much you are spending so that you can avoid using the overdraft as much as possible. Today almost all banks offer mobile and online banking services. This will make it easier for you to check your account quicker and in an easier way. You may also sign up for email or text alerts any time that you are overdrawing on our account. This would help you avoid the  charges. All of these tools can be quite handy. If you believe that it is too tempting to have an overdraft facility then the best thing to do would be to ask the bank to suspend your facility once you have cleared the debt.

2. Use Savings

If you realize that you are overdrawn most time of the month, then it indicates that there is a need to cancel out some of your debts or at least move on to cheaper accommodation. Another option is using your savings to pay off any overdraft debt that you may have. The interest amount that you will earn from the savings account would anyways be much lesser than what you will have to pay if you use the overdraft. If you do have any savings with you then the best thing to do is to use it to pay off your overdraft.

3. Use Your Credit Card

Another option that you may want to consider is to move your debt from the overdraft to credit card. This can be a good way to save money. This can be done simply by requesting for a transfer from credit card to current account. You will, however, have to consider the charges for transfer and the interest rate of your credit card to ensure that your overall cost for transferring the debt would be low. You will also have to come up with a good repayment plan to ensure that you will be able to clear your debt and not fall back in the same pattern since it would turn out to be a far worse situation otherwise.

4. Consider an Affordable Current Account

For quite a lot of people, moving to another current account may seem to be a very trying process but you will soon learn that it is quite easy to switch to another current account and enjoy savings on the fees and interest. The priority for you should be finding a current account that would offer you cheaper overdrafts. There are several good incentives that banks offer for switching that may motivate you.

Is It Possible to Have an Overdraft Free of Cost?

There are a few noteworthy exceptions to overdraft interest charges. Graduate and student accounts are the main ones which offer overdraft facilities free of cost. However, even though you may have a free overdraft you would still have to know about your limit so that you don’t have to incur charges and fees. You will still be paying for unarranged borrowing so you will have to be quite careful about it. You will also have to remember that you must not treat this free overdraft as your main borrowing method since you will have to start paying the interest on it after you graduate.

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