What is an overdraft?

When you take money out of a bank account beyond the funds you have in there, in other words, if you hit zero but keep withdrawing funds, you enter an overdraft. These overdrafts can be pre-arranged or unarranged, and different banks will have different terms and penalties for entering into an overdraft.

What’s the hidden cost of overdrafts?

Overdrafts are a double-edged sword. Borrowing extra money may occasionally help, but it has to be done carefully and responsibly. The main issue is that overdrafts encourage you to spend money you don’t have, often at a very high cost, causing two kinds of debts: financial debt and what we call ‘bad habit’ debts.

The financial debt is a problem because overdrafts are dangerously expensive. If you can’t afford to pay it off, it may affect your credit score- especially in cases with an unarranged overdraft- because it signals to lenders that you can’t manage your finances.

The bad habits of debt is often more insidious. Unlike financial debt that you can clearly measure with numbers, bad habits grow unnoticed, like lung cancer in smokers… until the day doctors show you the extent of the damage. When borrowing becomes habitual, your debt can get out of control- and you might not see the full extent of the damage until it’s too late. Overdrafts and cigarettes are the most widespread poisons that people can legally buy. The best thing you can do for your future self is to take control of your finances now. The sooner you confront your spending habits and realise the extent of your debts, the better.

HSBC overdraft fees

The Financial Conduct Authority (FCA) introduced stricter measures last year concerning overdraft interest rates, after their investigations revealed the harm being done to the most financially vulnerable.

Following this change in rules, the updated HSBC overdraft fees are far simple- but more importantly, far more expensive. The new interest rate applies to both arranged and unarranged overdrafts and is a flat annual rate of 39.9% variable- which is insanely high. With interest rates like that it becomes both incredibly costly to pay off and to build up savings.

For reference, Monzo responded to the rule change by introducing three tiers of interest payment ranging from 19-39% variable, depending on credit scores. By sticking with one flat rate, HSBC has made their overdrafts hugely expensive for everybody- including those with good credit scores. Assuming you have a good credit score and you get £500 into your overdraft, and it takes you a year to pay that money back, HSBC would charge you £199.5 interest. In contrast, Monzo would charge you £95- which is less than half of HSBC fees.

Other changes HSBC have made to make note of include the removal of their old £5 daily unarranged overdraft usage free for borrowing beyond the buffer and a reduction in the maximum monthly charge of £20

Depending on the amount you need to withdraw and the state of your credit score, there are massive savings out there for you if you can dodge those extortionate interest rates. Just remember, your overdraft is just another loan and more debt. Make sure you spend responsibly and keep on top of your finances!

Buffers

HSBC do offer their customers a small ‘buffer’, whereby you can overdraw by £25 without being charged interest. Although this seems like a good safety net for those who accidentally overcharge their cards, it is still encouraging users to spend more than they have. Whilst that’s okay if it’s within the £25 buffer, that habit can get dangerous fast. Debt is a tricky cycle to break.

Getting rid of overdrafts

Remember, overdrafts are just another debt that needs to be paid off. If you want to live debt-free, Cash Coach will help you pay off your debts and develop sustainable financial habits.

You can start for free, and eventually unlock advanced features for £35.88/year - which is a fraction of what banks would charge for having an overdraft.