Getting into an overdraft is an expensive habit to have, and we’re going to show you why. And with Monzo bank, the terms have gotten tougher.

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 are the hidden costs of an overdraft?

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.

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 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.

What’s the deal with Monzo?

The buffer

In previous years, Monzo offered a £20 ‘buffer’ for those who entered their overdrafts, whereby if you overspent by up to £20, you could do so interest-free. 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 £20 buffer, that habit can get dangerous fast. Debt is a tricky cycle to break.

Overdraft fees

Before new regulations were introduced over the summer, Monzo bank was charging 50p per day in overdraft fees- for those withdrawals beyond the £20 buffer. Now, they have been forced to change their policy, instead of charging customers a single interest rate when they overdraw and enter their overdrafts. Depending on your credit score, an overdraft with Monzo has an EAR of 19%, 29%, or 39% variable. This is bad enough if you have a good credit score but far worse if you don’t.

If you get £500 into your overdraft with an EAR of 39%, you’ll be paying just over £25 in interest- if you can pay it back in two months. If it takes you a year to pay it back that’s £195.

What is EAR?

EAR is the interest rate you would pay if your loan was taken out for a whole year. It takes into account the interest rate and compound interest (the interest you pay on your interest).

Getting rid of overdrafts

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

You can start for free, and eventually unlock advanced features for £7.99/month - which is a fraction of what banks would charge for having an overdraft.