The Co-operative Bank is freezing interest on current account overdrafts for the first three months of 2012, to help people with post-Christmas debts, the Guardian has reported. Many people see overdrafts as a necessity, and this scheme could help them to clear their overdraft more quickly. But an overdraft isn't always a good idea, especially for people already carrying other debts.
From authorised to unauthorised?
An overdraft may seem like an additional benefit with a bank account. From time to time, if you overspend, an authorised overdraft can stop you running out of cash and being charged for bounced payments. However, if you think you're likely to need an overdraft every month, it could indicate an underlying problem with your personal finances.
The deeper you go into your authorised overdraft, the more likely you are to dip into an 'unauthorised' overdraft (beyond your overdraft limit).
Authorised overdraft fees
You will be charged interest on most overdrafts. A quick look at a comparison of current accounts with overdrafts on the market at the moment shows some that don't charge for the first £100 of an overdraft, for example, or for the first 12 months a customer uses it. After that, the interest rates can be as high as some credit cards.
The Co-op, being transparent about its fees, says its interest freeze could save a current account customer with a £2,000 authorised overdraft £75 in fees in the first three months of this year alone. A customer with a £500 overdraft could save over £18.
Similarly, there are bank accounts out there - like the thinkbanking basic bank account - which are also transparent about their fees. The thinkbanking basic bank account has no overdraft and there are no 'hidden' fees or charges for bounced payments. There's a set-up fee of £25 and a monthly fee of £14.50 for the account, which also comes with budgeting support, designed to help people live within their means.
What if an overdraft was taken away?
Your bank reserves the right to reduce or remove your overdraft facility at any time, although banks assure customers they'll only do this in special circumstances. If you do have an overdraft, it's best to limit it to an amount you could repay if you had to.
Consider the following example: if a bank withdraws an overdraft facility because the account holder is having real financial difficulties - could they repay their full overdraft if they suddenly had to? If they couldn't, they could find themselves pursued by debt collectors, or end up with a CCJ (County Court Judgment) or worse.
An alternative to an overdraft
A basic bank account does not have an overdraft and even applicants who have had debt problems in the past should be able to open an account like this.
If you have an overdraft already and are concerned about your bank taking the facility away, one option could be opening a separate basic bank account and paying your income in there instead. You could set up a monthly Direct Debit to your old bank account and keep it going until that account is back in credit.