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Overdrafts: What you need to know

Not sure if an overdraft is classed as credit, or how it can impact your credit score? Our handy guide will explain what arranged and unarranged overdrafts are, and how they may affect you and your credit report.

If you’ve got a bank account, then you’ve probably come across the term ‘overdraft’ before. At Lowell, we know how important it is to understand financial terms to avoid any misunderstanding that could result in money problems.

That’s why we want to remove the stigma around having conversations related to money and debt and have written this guide about overdrafts so that you can make informed financial decisions.

In this guide, we’ll go through:

This content is intended to be an impartial guide regarding overdrafts, how they work, and what happens if you don’t pay your overdraft. Lowell Financial Ltd does not offer financial advice. You can find out more about the organisations you can contact in our guide on debt help and support.

What does an overdraft mean?

Overdrafts are linked to your current account and are a type of consumer credit. Having an arranged overdraft limit in place means that you’re able to spend more money than you have in your account – up to an agreed amount - and they are typically used as a short-term solution for unforeseen expenses.

What are the different types of overdrafts?

There are two different types of overdrafts – arranged and unarranged.

  • Arranged overdraft – Arranged overdrafts are when you’ve already agreed on a limit that you can spend with your bank in advance, they can also be called ‘authorised’ or ‘planned’ overdrafts.
  • Unarranged overdraft – Also referred to as ‘unplanned’ or ‘unauthorised’ overdrafts, this is when you spend more than you have available in your bank without having agreed on an amount with your bank first. This also includes if you go over the spending limit of an authorised overdraft.

Unless you have an interest-free arranged overdraft, a particular type of overdraft that doesn’t charge interest as long as you don’t go over the specified limit in your agreement, both types of overdrafts include charges if you use them. If you’re not sure what charges may apply to your account, then you can contact your bank to find out.

Is an overdraft a loan?

Since you’re borrowing money from the bank when you go into your overdraft, which is also referred to as becoming ‘overdrawn’, this does count as a form of credit or loan – aka overdraft debt.

How does an overdraft work?

Overdrafts work differently from other types of loans and credit cards as there is no official repayment plan, sometimes referred to as a rolling credit facility. Overdrafts are repayable ‘on demand’ which means that the bank could get in touch with you and ask for all the money back at any time.

How does an overdraft get paid back?

Once you’ve become overdrawn, interest will be charged on the amount of money borrowed. As overdraft interest is usually calculated daily, the faster you can pay it back, the less you’ll pay overall. When it comes to interest rates and fees, these are often higher for overdrafts compared to other types of loans given their short-term nature.

Before you decide to use your overdraft, it’s a good idea to check what you can afford. Our guide on how to create a budget and manage your money includes top tips to help you take control of your finances and see if this is an option for you. You can also seek free and independent advice from other organisations like StepChange and Citizens Advice.

If you’re struggling with your finances and still need to pay off your overdraft, then it’s important to contact your bank and explain your situation.

Is it good to have an overdraft and not use it?

If you’ve got an arranged overdraft that you don’t use, this may not appear on your credit report, and therefore have no impact on your credit score, as the balance is consistently zero.

Depending on your personal situation, you can decide to cancel your overdraft if you don’t plan on using it. You can find out more about this in our section on ‘How to cancel an overdraft’.

What happens if you go over your overdraft?

Whether you go over your arranged overdraft limit or spend more money than is available in your account without an arranged overdraft in place, this is classed as an unarranged overdraft. The potential consequences of an unarranged overdraft can vary slightly depending on your particular bank and your individual situation.

Generally speaking, overdrafts can be an expensive way to borrow money due to high interest fees which will be applied the moment you go into your overdraft. Even with an interest-free overdraft, once you go over your limit, you could still be charged interest on anything you spend over the interest-free amount.

Regularly using an unarranged overdraft may also impact your credit rating and ability to borrow in the future. We’ll explore this in more detail in our section further down on ‘Does an overdraft impact your credit score?’

With overdrafts, your bank has the right to ask for repayment, reduce or withdraw the overdraft and ask for repayment, or refuse payments due to lack of funds at any time. If you’re struggling to pay back your overdraft, you should let your bank know as soon as possible to avoid other potential consequences – we explain the potential action your bank might take in the below section, ‘What happens if I can’t pay my overdraft?’

What happens if I can't pay my overdraft?

Perhaps you’re wondering ‘what happens if I can’t pay my overdraft’? In the UK, you might receive a default notice from your bank if you don’t pay. This is a letter to warn you that you need to pay off your overdraft debt or the account will be closed.

Your creditor will give you a remedy period to bring your account up to date. If you don’t clear your overdraft debt or haven’t agreed a repayment plan within this time then they may take further action. This could include additional contact, passing the debt to another firm or applying to the court to recover the money.

If you let your bank know that your financial situation has changed, they may be able to temporarily pause interest and fees on your overdraft debt or allow you to pay essential costs like food and bills before clearing your overdraft.

MoneyHelper has a useful guide on overdrafts which includes various tips for controlling your overdraft and avoiding additional costs.

Does an overdraft impact your credit score?

Like other loans, an overdraft can impact your credit score. If you have an active overdraft, this will appear in your credit file as a debt. Lenders who look at your credit file will be able to see:

  • Your overdraft limit
  • How often you use your overdraft
  • How much you spend when you get overdrawn
  • How often you pay back your overdraft debt

With an arranged overdraft, as long as you pay back what you owe on time then your score is unlikely to be impacted. However, going into an unarranged overdraft could negatively impact your score and make it more difficult to get future credit.

Can an overdraft be cancelled?

Yes, you can cancel or reduce an arranged overdraft if you don’t think that you’re going to use this facility, or for some other reason. However, it’s worth noting that if you do cancel or reduce it and then spend more than your account balance then you might go into an unarranged overdraft which may be more expensive.

How to cancel an overdraft

To cancel an arranged overdraft, the balance will need to be in credit, meaning that the balance is zero and you don’t need to make any repayments. If you have been using it and still owe money, you’ll need to pay off that amount first.

Once you’ve done that, you’ll need to get in touch with the bank to cancel it – usually, you can either do this in branch, over the phone, or through online/mobile banking.

Can a bank take away your overdraft without telling you?

If your bank thinks that you’ve been using your overdraft too often and are struggling with your finances, they might cancel your overdraft. However, if they do so without warning then you might be able to raise a complaint with the Financial Ombudsman Service.

Is my Lowell debt an overdraft debt?

Here at Lowell, we’re a debt collection company and we buy debt from other companies including banks. That’s why you might feel like you’ve heard from us out of the blue. Once Lowell has bought your debt, we become the legal owners and any outstanding balance is owed to us. To find out more about what we do, we’ve got a guide explaining how debt purchasing works.

If you’ve been contacted by us, please do get back in touch so we can work together and begin your journey to becoming debt-free with Lowell.

For more helpful guides covering a wide range of debt-related topics, you can visit our debt guidance hub. And if you’ve got a Lowell debt and have any questions or concerns, please get in touch with our friendly team so we can help you find the right solution. Alternatively, you can manage your account independently online through our easy-to-use online portal.

First published: 19th June, 2023

Last Updated: 8th November, 2024