Most of the people lack adequate knowledge regarding overdraft debt. This can lead to many financial problems, complications, and at times, can even cause extreme anxiety.
Fortunately, overdraft debt is easily understandable and if you don’t know what it is, don’t worry because you’ve landed on the right post.
I am going to tell you all about bank account overdraft, how to utilize it, and how to get out of it when things start to get messy.
What is Overdraft Debt?
Overdraft is a facility that is provided by your banks to draft more money out of your bank account than the existing available balance.
In simple terms, you can make extra money even when your bank account balance has dropped to 0. It falls in a category of short term loans.
The bank overdraft service is only available on Current Account and is provided to certain customers whom the bank’s financial conduct authority seems fit. The overdraft charges an interest rate on the drafted amount.
The interest rates might differ from bank to bank and according to the amount of overdraft. However, after the Coronavirus pandemic, UK banks have increased their overdraft rates. For example, Barclays is set to increase its overdraft rate by up to 35%.
Overdraft is an effective and quick way to manage your cash flow, this method of borrowing is most suitable for businesses who are expecting cash shortfalls in their budgets. For a layman, on the other hand, this might be an expensive option.
If you want to use a bank overdraft method for personal money needs, I would strongly recommend you to get a credit card or an interest-free credit card instead.
If not managed properly, it can get quite difficult to pay off your overdraft due to the higher APR compared against credit cards and loans.
What Happens if I Can’t Pay Back My Overdraft?
If you don’t pay off your overdraft there might be many repercussions. I have listed down some of them below for you:
Adverse Credit Rating
Not paying back your overdraft limit or amount might have a serious and long-lasting negative effect on your credit score. Your bank or the institution might file all the credit scores in your credit data history which will definitely make it harder for you to avail any kind of credit again.
Fees and Charges
Leaving your overdraft debt unattended will cause extra charges and the late fees being implicated upon you. This will surely increase your debt and make it difficult to pay it back in due time.
Account Defaulting
If you have not paid your overdraft limit amount back to the bank for years, the bank might declare your account as default.
Labeling your account defaulted in banking terms means ‘failure to repay’. Getting your account defaulted can put many hurdles and negative impacts on your financial life and ease.
- Firstly, this data might be shared with different institutions and make you unable to open a bank account anywhere.
- Secondly, getting defaulted might result in legal action. This will not be a good looking scenario for you and for your financial life.
The bank is also in authority to freeze your credit cards and other banking facilities that you might be availing at that time, such as, direct debits, transfer credit, money transfer and etc.
Legal Action
The bank can pursue a legal course of action to recover the debts. It is totally up to the bank to decide whether to opt for legal action or not. In most scenarios where the overdraft amount is quite large, this choice of action is usually combined with account defaulting.
How Can I Get Out of My Overdraft?
With proper debt planning and planned course action, you can easily find your way out of overdraft debt. Let me advise you on some easy ways out that are not only effective but also generally applicable for everyone.
Savings
Savings are one of the most important parts of a stable financial life.
‘Paying yourself first’ – this term means that when you receive your paycheck or get your hands upon the hard-earned money, keep a portion of it for yourself first and then budget the remaining according to your needs.
By following this method consistently, you will be able to save a good amount of money in a short time. Use this money to pay back your overdraft, and get out of this high APR debt.
I would advise you to start saving either 10% or 15% of your Gross Income.
Credit Card
Credit cards can be a useful way to overcome your overdraft amount. Pay the amount owed with your credit card. By doing this, you will shift a high-interest debt towards a low one. It is a smart and effective way to manage high-interest debts.
Reduce Your Overdraft Limit
Another effective and simple way is to just reduce the overdraft limit.
If you use the overdraft facility of your account quite frequently, it would be a wise decision to reduce the limit of your account. Thus, it is easier to pay back when the time arrives.
Watch Your Spending Habits
Excessive or bad spending habits might be the final nail in the coffin for your financial well-being. Review your needs and wants, budget your income accordingly, and try to live below your means if you are having a hard time to pay up your debts.
An effective way to overcome your bad spending habits is the 1-month rule:
This rule states that if you decide to buy something, just hold on and wait for 1 month and consider that purchasing decision again, if you still have a desire for it, go ahead!
This rule can save you a lot of money if followed consistently
Take Up Freelance Work
If you want to get rid of your overdraft debt or any debt in that regard, I would definitely suggest you find ways to increase your income.
Freelancing is a good opportunity to increase your income flow. Generating income from multiple sources is an effective idea in order to achieve financial freedom.
Pick a skill that you are good at, work on it, and start taking freelance assignments for it. You can even offer your services (for free) on different websites such as Fiverr to a wide audience.
Can I Pay Off My Overdraft in Instalments?
Yes, like almost every other kind of debt, overdraft debt can also be paid off instalments.
Simply write a letter to your bank stating the installment plan and every relative detail. I am sure they will acknowledge it and allow you to install your overdraft.
FAQs
Does overdraft affect my credit score?
As mentioned above, if you don’t manage your overdraft properly, it might cause an adverse effect on your credit score. However, taking an overdraft in itself will never affect your credit score, paying or not paying it will do so.
If you pay your overdraft on time and in proper amounts, this can also help you to increase your credit score positively.
Can I withdraw money if I have a negative balance?
If you have not reached your overdraft limit, you will be able to withdraw money from your account.
For example, even if your account has a negative balance of £5000 but your overdraft limit is £10000, you will be able to withdraw amounts until it reaches the limit of £10000.
What happens if your account is overdrawn for too long?
If your account is overdrawn for too long, the result might be that your account gets defaulted.
So, in this case, I would personally advise you not to leave your account overdrawn for too long, it is better to pay the debt than getting defaulted.
What’s better, overdraft, or credit card?
It really depends on your financial needs.
Overdrafts are an effective way for many businesses who experience cash shortfalls or work in the seasonal industry. However, in my opinion, for personal usage and expenses, an overdraft is an expensive option when compared to credit cards.
I would recommend that you use a credit card instead because of their lower interest rates. It will be quite easier to pay up your credit card bill instead of paying a high-interest overdraft.
Do you need good credit for an overdraft?
Yes!
Good credit is important to avail of the overdraft facility. Without that, you have fewer chances of getting your overdraft application approved by the lending institution.
Final Thoughts
Overdraft is a risky and high-interest borrowing option. However, don’t think that it is completely useless.
‘The higher the risk the higher the reward’ – the statement does have some truth to it!
If you are able to comprehensively manage your overdraft, it can do wonders and be a complete game-changer.