Halve the cost of your overdraft

We show you how to reduce the interest you pay on your overdraft by half - or even more!

Having broken records in early 2009, the cost of going overdrawn has climbed even further this year to the extraordinary height of 19.4%, the highest since Bank of England records started in 1995.

If you take two years to get clear of your current account overdraft at that rate, you can expect to pay around £200 in interest per £1,000 borrowed. The exact amount will depend on your average overdraft throughout the month.

What's more astounding is that I'm talking about agreed overdraft limits only, so this doesn't include penalties for going more overdrawn than you're supposed to.

However, we could pay half as much in interest, or even just a fraction of it. And how many of us wouldn't put in a little effort to save possibly hundreds of pounds a year?

1. Firstly, switch current account

It is very simple to make big savings and this first method won't just halve the cost of your overdraft, it could actually reduce the interest you pay by 80% to 90%.

Let's say you have a starting overdraft of £5,000 and earn £1,600 after tax each month. If you're saving £200pm towards paying interest and reducing your debt, it could take you over two-and-a-half years to get permanently into the black at a total cost of about £900 in interest.

You can do a lot better than that.

The best current account available is Santander's Preferred Current Account. I say “best” because it offers the best deals on overdrafts as well as positive balances, but you have to balance that against the bank's poor reputation for customer service. (Although it has taken big steps to reduce problems, as I explained in Santander reduces complaints by a third.)

If you switch to this account you could get an interest-free overdraft for 12 months equal to your previous overdraft up to a maximum of £5,000, subject to its assessment of your credit status. Compared to average overdraft interest rates, you would save £600 in interest in the first year alone.

Ideally you'll shop around again in a year, but even if you stick with Santander the following year, it will charge you up to £5 per month when you go into your agreed overdraft. You will be completely out of your overdraft in about a year and over the two years you can expect to have saved more than  £800 against the average agreed overdraft rate, plus you'll be permanently in the black several months earlier.

What's more, you get £100 cashback just for making Santander your main account. That covers all the £5 charges you will receive in the second year, so you will effectively have paid off your entire overdraft at zero cost.

2. Transfer overdraft debt to an interest-free credit card

If Santander doesn't grant a large enough overdraft, you could first write to the bank explaining more about yourself and why you're a good customer, and ask for a higher limit. Writing to banks often produces results.

Failing that, or if your overdraft is greater than £5,000 anyway, you will need to look elsewhere for your remaining debt, which might still be costing you 19.4% APR per year.

MBNA allows you to transfer overdraft debt to many of its credit card brands, including Virgin Money credit cards. It costs you a 4% fee and then you pay zero interest, sometimes for more than a year. In the case of one Virgin card you can get 20 months free from interest.

If you repay the debt in equal instalments over a year, you'll reduce the total cost by more than half. If you need the full 20 months, the cost savings will be even greater.

However, if you're able to pay off that debt inside three to five months, it'd probably work out cheaper to shun the 4% fee and stick with your existing overdraft.

3. Snowballing

Finally, if you're unable to get your interest down to zero on the whole debt by switching current account and using a credit card, the best thing you can do is pay off the debt with the highest interest rate fastest, and make just minimal contributions to your other debts. Once that debt is paid off, put your spare money into reducing the next highest rate.

This extremely simple trick could easily halve the interest you pay if you have more than one debt.

More: compare current accounts and credit cards | 10 top tips for personal loans | The smartest balance transfer card