The alternatives to overdraft borrowing

Over the next few months, many high street banks will be implementing new overdraft charges, which is in response to new rulings by the Financial Conduct Authority (FCA). With these overdraft changes hitting the headlines, we’ve taken an in-depth look at the changes that are due to be made, along with alternative borrowing options.

Banks and building societies were required to make changes to their overdraft fees after the FCA banned fixed fees on overdrafts and ruled that unarranged overdraft fees cannot be charged at a higher rate than arranged overdraft fees.

Already, Lloyds, Bank of Scotland, Halifax, Santander, Barclays and TSB have announced that they will be changing their overdraft fees in the spring. Many banks will now charge customers up to 39.90% EAR, however some banks and building societies will be charging a much lower rate, such as Starling Bank, which is keeping its arranged overdraft fee at 15.00% EAR. Virgin Money, Clydesdale Bank and Yorkshire Bank are the latest banks to reveal their new overdraft fees, which are increasing their fee from 12.50% EAR to 19.90% EAR. In addition to this, Metro Bank already follows the new overdraft rules so did not make any changes to its overdraft fees.

Here, we reveal all the new overdraft charges that are due to be implemented:

While the new overdraft fees seem high, the FCA has stated that seven out of 10 overdraft users will be better off or see no change when the new overdraft fees are introduced. Christopher Woolard, executive director of strategy and competition at the FCA, said: “Seven out of 10 overdraft users will be better off or see no change. At two banks that figure is nine out of 10. Consumers can now see how expensive overdrafts really are. Those who are worse off should consider shopping around to find a cheaper deal. Credit and other forms of borrowing can be significantly cheaper for long-term users.”

Even before the overdraft fee changes were announced, many consumers who had borrowed a substantial amount through their overdraft had found themselves in a cycle of overdraft debt that had become difficult to escape from, with overdraft fee charges contributing to the problem. One reason why the FCA introduced the new overdraft rules was to help make overdraft charges simpler for consumers to understand and help prevent banks from charging high rates for those who used an unarranged overdraft.

Saying this, even with the new overdraft fees abiding by the rule changes, borrowing via an overdraft is expensive. This is because overdrafts were initially meant as a short-term form of borrowing, which consumers could dip into on occasions when they needed to borrow a small amount of money, and not meant as a long-term borrowing option. As a result, lenders often discourage long-term borrowing through overdrafts by applying higher charges than on other types of borrowing. To avoid high overdraft charges, consumers should consider other options for long-term borrowing.

Credit cards and loans are both popular forms of borrowing that now often charge a lower rate than overdraft fees. For those looking to borrow a small amount in the short-term, some credit cards offer 0% interest on purchases for terms of over two years. For consumers needing to borrow a larger amount and who are looking to repay it over a longer period of time, some personal loans can charge as little as 2.8% APR for borrowing £12,500 over a five-year period for example. It should be noted, however, that the rate the lender will offer on a loan will depend on the applicant’s credit rating, which means that they may be charged interest higher than the headline rate. In addition to this, credit card applications may be declined, which can be due to a number of reasons, but credit scores often have an impact on whether credit card applications are successful, as well as the APR offered.

A 0% purchase credit card is often a good option for consumers wanting to borrow over a short period of time. Sainsbury’s Bank’s Dual Offer Credit Card Mastercard is currently offering the longest term of 27 months within the 0% introductory purchase credit card chart. This card requires a minimum income of £10,000 and after the interest-free period ends it charges 20.9% APR, which is significantly lower than the new overdraft fees being charged by many banks.

Two providers offer 0% purchase rates for a period of 26 months. MBNA Limited offers this interest-free term on its 0% Transfer and Purchase Credit Card Mastercard. This card only applies the 0% interest on purchases made in the first 60 days of the card being issued and applicants need to have a minimum income of £14,000. After the interest-free period comes to an end, it charges 20.9% APR.

Santander offers 0% interest for 26 months with its All in One Credit Card Mastercard. A £7,500 minimum income is needed for this card, which has a monthly fee of £3. Borrowers should take the fee into account when deciding if this credit card will make borrowing cheaper than overdrafts and it is likely to only be worthwhile for those borrowing a higher amount, for example £500 or more. Once its interest-free period ends it charges 21.7% APR.

Loans are designed to enable consumers to borrow a larger amount over a longer period of time. Those looking to borrow £5,000 over a two-year period for example, can get the lowest rate of 3.4% APR, which would mean that they would repay a total of £5,176.32 over the two years. Alternatively, consumers looking to borrow a higher amount of £12,500 over a longer period of five years will find that the lowest rate currently available in the chart is 2.8%, which would result in them repaying a total of £13,398.00 over five years.

Commenting on whether consumers should consider an overdraft, credit card or loan as a form of credit, Rachel Springall, finance expert at Moneyfactscompare.co.uk, said: “Borrowing over the short-term will need careful planning and an overdraft may appear to be the most convenience method in this respect. However, due to the upcoming changes, some borrowers may find it cheaper to use a credit card as there are some out there charging lower rates. Not only can it be cheaper to borrow using a credit card, but consumers can also benefit from additional protection under the Section 75 of the Consumer Credit Act. It may well be that consumers choose to use an overdraft less frequently moving forward – but this isn’t just due to these changes to interest rates. In recent months consumers would have found that their ‘available balance’ has changed when checking their bank account funds, so they might think twice about dipping into their overdraft.”