18/02/20What do overdraft changes mean for you?
Banks have been ordered not to charge customers more for an unarranged overdraft than for an arranged one from April 1st 2020. That might sound like a good idea for those struggling with debt, but many banks have simply increased their charges across the board.
Whilst overdrafts are linked to poor money management in some cases, there are many circumstances where having an overdraft can be useful. You may use an overdraft as a buffer in case purchases or direct debits are higher than expected. Or you may use an overdraft as a short-term credit option. For some people, an overdraft can provide peace of mind and they may be a part of your financial plan.
However, the incoming changes may mean that your current overdraft facilities are no longer the best option for your needs.
FCA labels overdraft market ‘dysfunctional’
The Financial Conduct Authority (FCA) reformed the overdraft market after labelling it ‘dysfunctional’. In particular, it highlighted that consumers found it difficult to understand what charges they were paying. It also found that those using unarranged overdrafts were facing very high charges, in some cases ten times the cost of using a payday lender.
As a result, the FCA has ended high unarranged charges. It is estimated that a borrower that uses an unarranged overdraft over seven days will save around £55. In addition to ruling that unarranged overdrafts costs will be no higher than those for arranged overdrafts, there are two other main changes:
1. Interest on all overdrafts will be charged at a single annual interest rate (APR) to reduce consumer confusion around how much is charged
2. There will be no daily and monthly fees for using your overdraft
What impact will it have for you?
First, if you have used an unarranged overdraft in the past or may do so in the future, the FCA changes are likely to be positive for you. They will limit how much you pay in charges and fees.
However, if you have an authorised overdraft it could cost you more. It is estimated that eight million overdraft users will be worse off due to the changes. This is because several banks have hiked their charges for authorised overdrafts in a bid to plug the gap they will face as unauthorised overdraft charges are cut. Among the banks to have announced a higher rate for all overdrafts, when compared to their old arranged ones, are:
- Lloyds Banking Group
- Royal Bank of Scotland
Some authorised overdraft users will see their charge increase sharply to 40% or more.
The FCA has since contacted major banks and has asked them to provide evidence of how they arrived at their pricing decisions. The regulator has said it expects firms to take positive steps to help customers that may be worse off or in financial difficulties as a result of the changes. For example, firms could choose to:
- Reduce or waive interest
- Offer a continuation of overdraft borrowing at the current rate of interest
- Agree a repayment plan
Whether you have an arranged overdraft or not, it is important to contact your bank and understand what using an overdraft will cost you. If you use an overdraft, check your current interest rate and whether this will change in April. If you are unsure, contact your provider.
3 alternatives to using your overdraft
If you find that you are regularly using an overdraft facility, it may be time to reassess your budget. However, occasionally using an overdraft can be useful. If you have found that they will now cost you more, there are alternative solutions, including these three:
1. Dip into savings: It is likely that the interest you are earning on savings is low and far below what you would pay to use an overdraft. As a result, if you have accessible savings, such as an emergency fund, it may be better if you use these rather than an overdraft. However, you should make a plan for topping your savings back up. You should also check if any restrictions or penalties apply when accessing savings, for example, Individual Savings Accounts have an annual subscription limit which may make it difficult to replenish savings, or you could lose a competitive interest rate for making a withdrawal from other accounts.
2. Use a credit card: Depending on your credit card, it may be cheaper to make purchases on a credit card rather than using an overdraft. This will depend on your personal circumstances and the terms offered to you by a provider. If you have an existing credit card, it is worth checking the interest rate and how it compares to overdraft charges. Taking out a new credit card may also give you access to introductory offers, such as 0% on purchases for a defined period of time.
3. Take out a loan: If you want to borrow over a long timeframe, using an overdraft often is not the most efficient way of accessing credit. In many cases, a personal loan will be more suitable and reduce the cost of borrowing. Again, the interest rate you access when taking out a loan will depend on your personal circumstances.
If you would like to discuss your current financial plan and use of overdrafts, please contact us. We will work with you to understand the more efficient way to access credit should you need to and what your alternatives are.