Overdraft mistake that could cost over £500 a year – and how to avoid it

MILLIONS of households could be paying over the odds when borrowing money through an overdraft.

They can be handy if you find yourself in an emergency and need access to cash quickly.

But overdrafts are among the most expensive forms of borrowing, with most banks now charging 39.9% interest on the average account.

It means that if someone was to borrow £2,000 from their overdraft for 20 days per month across the year they’d owe £524.76 worth of interest.

But the average interest rate charged on credit card bowering comes out at 23.9%.

It means that if someone was to borrow the same amount on their plastic for 20 days per month across the year they’d owe £3.14.28 worth of interest.

This is a saving of £210.48 compared to those who choose to borrow the same amount from the average current account overdraft.

It’s important to remember that how much you pay in interest will depend both on the amount of money you borrow and the interest rate available to you.

In an ideal world, bank account holders should repay their overdraft in full each month.

However, every month 15.5 million adults (30%) dip into their overdraft and borrow a whopping £3.5billion, according to research by MoneyComms and TotallyMoney.

Andrew Hagger, personal finance expert, Moneycomms.co.uk said: “There’s no reason why consumers should be paying rip off overdraft rates of near 40% for agreed borrowing, there are cheaper alternatives such as credit cards which cost around half as much.

“An overdraft may be a useful buffer to help with cash flow issues, but using a credit card instead can slash your interest charges, more so if you can pay it off in full each month.”

But borrowing through credit cards and overdrafts sounds like a simple way to help pay the bills – it’s not worth falling into debt over.

It’s also vital to ask yourself if you actually need to borrow before committing to a new credit card, personal loan or overdraft.

If you cannot afford to pay off a debt you currently have, then you should avoid taking out any more debt at all costs.

Alastair Douglas, chief executive of TotallyMoney said: “Overdrafts can be a ghost debt for some.

They’re an extension of a customer’s current account, with no separate bills, cards or apps to manage it.

“They can almost go unnoticed, while some might not even treat them as a ‘real’ debt.

“But the truth is that banks make a lot of money from overdrafts, as they’re an easy way for them to charge customers high rates of interest for accessing extra cash.”

But if you do need to borrow, we’ve listed the tricks to cut your costs below.

How can I reduce borrowing costs?

The first thing borrowers can do is try to improve their credit scores.

Boost your credit score

Getting on the electoral register is a must when it comes to building a decent credit score.

This proves who you are and where you live meaning it’s easier to get credit if you’re on the list.

It is also wise to check the electoral roll for any errors. You can sign up by registering to vote.

Don’t make too many credit applications as it can be seen as a sign of financial distress – and each application will be recorded on your file.

Use a “soft-search” eligibility calculator to show how likely you are to be accepted.

Always pay your bills as late payments are also recorded in your file.

Try and cut down your existing debt before applying for new credit as lenders may be reluctant to lend to you if you already have a large amount of debt.

The best credit card deals – with the lowest rates, biggest limits, cheapest fees and longest interest-free windows – are reserved for those with top-notch credit scores. 

Lighten your loans

If you took out a loan a couple of years ago, it may be worth searching for a better deal.

Using a new loan at a lower rate to pay off an old one can sometimes make sense.

But remember, not everyone gets the rates advertised by lenders, as these are reserved for those with good credit ratings.

Check which loans you’re most likely to get without damaging your score by using an eligibility tool such as the one on Compare The Market or MoneySavingExpert.com.

Blitz your credit card balance

Do not let credit card debt linger. If you’re just paying the minimum each month, it could take decades to clear.

Only making the average 2.5% minimum monthly payment on a £5,000 balance means it would take you nearly 38 years to pay back and cost nearly £15,000 in total, on a interest rate of 22%.

Switch to a balance transfer credit card to get a window of up to 34 months with no interest charged.

Break the total debt down into monthly payments and set up a direct debit to ensure you wipe the balance in that time.

If that’s impossible, try to switch again to a new card.

But not everyone can get the top balance transfer deals, as they require an excellent credit score.

Find out which cards you’re most likely to get with the eligibility checkers on Go Compare or Uswitch.