Most people only discover how their overdraft really works on the day it costs them money. The card gets declined at the till, or a direct debit bounces, and suddenly there is a charge sitting on the statement that nobody quite remembers agreeing to. Overdrafts are the quietest form of borrowing in Britain, and since the FCA forced banks to rebuild how they price them back in April 2020, they have also become one of the most expensive on a pound-for-pound basis. A typical high-street arranged overdraft now charges around 39.9% EAR, and some sit closer to 49.9%. That is dearer than most credit cards, and far dearer than a planned personal loan.
The strange part is that almost everyone treats the overdraft as a feature of the current account rather than as a credit product. It isn't. It is a line of credit that the bank can reduce or remove, that the FCA regulates, and that shows up on your credit file the same way a loan does. Understanding the mechanics before you lean on one is the difference between a £3 buffer and a £40 month.
Arranged versus unarranged — and why the gap finally closed
An arranged overdraft is a limit your bank has agreed in advance. You apply, they run a check, and you get permission to go into the red up to, say, £500. An unarranged overdraft is what happens when you spend past that limit, or go overdrawn with no facility at all. For years, unarranged borrowing was where banks made the cruel money — fixed daily fees of £5 or £6, paid-item charges of £10 a pop, the lot. Someone £20 overdrawn for a week could end up paying more in fees than the £20 itself.
The FCA's overdraft reforms changed the model entirely. Banks can no longer charge higher prices for unarranged borrowing than for arranged, and fixed daily and monthly fees were effectively banned in favour of a single simple interest rate expressed as an EAR. That sounds like good news, and for heavy unarranged users it genuinely was. But the same rules pushed arranged rates up sharply — most major banks landed on a near-identical 39.9% EAR, which the FCA itself noted looked suspiciously like the market moving in lockstep. The headline charge is cleaner now. It is not cheaper for the average borrower who lives in a small arranged overdraft month after month.
What an overdraft actually costs you in pounds
Interest is charged daily on the amount you are overdrawn, then usually billed monthly. The arithmetic is worth doing once, because the percentage hides how it feels. At 39.9% EAR, being £500 overdrawn for a full month costs roughly £14 to £15 in interest. Stay there all year and you are paying somewhere near £170 for the privilege of a £500 buffer you never actually clear. Drop to £250 of usage and you halve that. The figure scales with how much you use and how long you sit in it — not with your limit, which is the single most misunderstood point. A £2,000 arranged limit costs you nothing if you never dip into it.
Where the overdraft beats the alternatives — and where it loses badly
There is a real case for an overdraft, and it is narrow: genuinely short-term, genuinely small, genuinely occasional. If your salary lands on the 28th and you slip £150 into the red for four days every couple of months, the interest is pennies and the flexibility is worth it. No application each time, no fixed repayment schedule, money there the instant you need it. For that pattern, an overdraft is the right tool and a loan would be overkill.
The picture flips the moment the borrowing becomes structural. If you are living in your overdraft — overdrawn on payday, clawing back to zero by month-end, then straight back under — you are not using a buffer, you are servicing a permanent debt at one of the highest rates available to ordinary borrowers. This is the trap. The overdraft feels invisible because there is no monthly bill landing through the door, no statement demanding a minimum payment. The cost just leaks out of your balance.
If that is you, move the debt. A 0% money-transfer credit card can shift overdraft borrowing into an interest-free window, though watch the transfer fee, which typically runs 3% to 4%. A small personal loan at 10% to 15% APR will cost a fraction of 39.9% and forces the discipline of a fixed end date. Even a credit union loan, often capped well below the high-street banks, beats sitting in the red indefinitely. The best option depends on the amount and your credit profile, but almost anything beats a permanent arranged overdraft.
The bits the bank doesn't put on the leaflet
Overdrafts affect your credit file, and not always in the way you would guess. Having an arranged facility you rarely use is broadly neutral, sometimes mildly positive — it is available credit you are managing sensibly. Being persistently maxed out against your limit, on the other hand, pushes up your credit utilisation and lenders read that as strain. The FCA introduced "repeat use" rules precisely because regular heavy overdraft use is a recognised marker of financial difficulty, and your bank is now obliged to contact you if you are stuck in that pattern. If you get one of those letters, it is not a sales nudge. It is a flag.
A few practical things genuinely move the needle. Ask your bank to lower your unused limit if a high number tempts you, or raise it modestly if a too-tight limit keeps triggering declines. Check whether your account offers an interest-free buffer — many do, commonly the first £25 to £50, below which no interest accrues at all. And know your bank's "retry" timing: most attempt a failed direct debit again the next working day, which gives you a small window to move money across before any consequence lands.
If you're switching accounts, the overdraft moves too
One detail catches people out under the Current Account Switch Service. When you switch banks, an arranged overdraft does not automatically transfer at the same size — the new bank decides whether to match it based on its own checks. Switch while overdrawn and you could find the new provider offers a smaller limit, or wants the existing balance cleared. If you rely on the facility, confirm the new limit in writing before you trigger the seven-working-day switch, not after.
The honest verdict
An overdraft is a fire extinguisher, not a tap. Kept for the rare four-day gap before payday, it is cheap, instant and genuinely useful, and there is no reason to feel bad about using it that way. Treated as a permanent extension of your income, it quietly becomes one of the worst-value debts you can hold — worse than the credit card you would feel guilty about, precisely because it never sends you a bill to feel guilty about. The rate is the same 39.9% either way. What changes is how long you stay in it. Borrow for days, not months, and the maths stays on your side.