What Is a Current Account Overdraft and How Does It Work?
Understand how current account overdrafts work in the UK, the difference between arranged and unarranged overdrafts, and when cheaper alternatives exist.
What Is a Current Account Overdraft and How Does It Work?
An overdraft allows you to spend more money than you have in your current account, up to an agreed limit. It's one of the most widely used forms of credit in the UK — and one of the most misunderstood.
Types of Overdraft
- Arranged overdraft: Pre-agreed with your bank. You have an approved limit and typically pay a daily fee or interest while in the overdraft.
- Unarranged overdraft: Going over your agreed limit, or below zero without a prior arrangement. Since 2020, banks must charge the same rate for arranged and unarranged overdrafts — meaning no punitive fees, but the rate can still be high.
How Overdraft Interest Works
Following FCA reforms in 2020, all overdraft interest is charged as an EAR (Equivalent Annual Rate), making it directly comparable to other credit products. Typical rates range from 19% to 40% EAR — which is expensive.
When Overdrafts Make Sense
- Bridging a short-term cash flow gap (a few days before payday)
- Genuine emergencies where other options aren't available
When to Avoid Them
If you're consistently in your overdraft for most of the month, it's a sign of structural financial difficulty. A personal loan or 0% credit card at a lower rate would be cheaper for longer-term borrowing.
Reducing Your Overdraft Reliance
- Set up a savings buffer of one month's expenses
- Consider a money transfer credit card to move the overdraft balance to a 0% facility
- Review your direct debits and ensure they're timed after payday
