Is Your Overdraft An Ogre?

Slipping into the red during the post-Christmas financial hangover could cost you an arm and a leg. We reveal the rip-off overdrafts.

Although we're not even halfway through the first month of the New Year, millions of people are feeling the financial strain of Christmas. Having shopped until they dropped in December, British borrowers are under the cosh as Christmas credit-card bills hit the doormat.

Even worse, workers who have to wait until the end of the month before being paid often find that they have a lot more January than they have money. Thus, many slip into the red and end up relying on an overdraft to keep them afloat.

Of course, some overdrafts are nicer than others, as the cost of this short-term borrowing varies enormously. At one end of the scale, an approved overdraft from a Best Buy current account can cost you nothing, thanks to special offers. For example, the Alliance & Leicester Premier Direct account charges no interest on overdrafts of up to £2,500 in your first year as a customer, making it an outright winner.

At the other end of the spectrum, we have the common-or-garden bank accounts which charge an arm and a leg for overdrafts. Indeed, the cost of an unarranged overdraft can be astronomical, whether the payments are returned ('bounced') or accepted.

According to research from Fool partner Moneyfacts, the cost of an unauthorised overdraft is almost twice that of an approved overdraft -- and that's before taking additional charges into account. In fact, the average interest rate for an authorised overdraft is 12.1% a year, compared to 23.3% when you slip into the red without permission.

Now let's assume that you go overdrawn (or exceed your overdraft limit) by £100 for a fortnight before restoring your account to order. How much would you expect to pay in penalty charges for this minor lapse? Perhaps ten or twenty pounds would be fair, agreed? Alas, in reality, the true charges are massively greater, as the following table shows:

The total cost of a £100 unauthorised overdraft for two weeks

(These calculations are for a single item being presented to your account which results in a £100 overdraft. If additional items are paid or returned, then these charges will increase still further.)

Source: Moneyfacts

Take a good hard look at the above table, because it's a real eye-opener. How on earth can Lloyds TSB get away with charging almost £166 for this unapproved borrowing, when HSBC is content to charge under £26? What possible justification can Lloyds TSB have for charging £140 more -- or 6½ times as much -- for the same service?

Frankly, there is no conceivable legal or business justification for charging such a sky-high sum for this level of borrowing. Amazingly, Lloyds TSB revamped its overdraft charges late last year, claiming that most of its customers would be better off under its new tariffs. Nevertheless, I believe that Lloyds TSB customers are being plundered by pirates every time they slip into the red without approval!

Then again, there is some hope on the horizon for fed-up bank customers. The Office of Fair Trading (OFT) is taking leading banks to court, arguing that their fees for overdraft charges are unlawful under the Unfair Terms in Consumer Contracts Regulations.

As an ex-banker, I know full well that the true cost of providing unauthorised overdrafts is a fraction of the above charges. Hence, I can't imagine that the OFT will lose its case, but the banks won't give up without a fight. After all, they make billions of pounds a year from rip-off overdraft interest rates and fees, so they want to hang onto this revenue at all costs.

Rather than going overdrawn without permission, I'd urge you to contact your bank before you exceed your limit for approved borrowing. It will be far cheaper to pay, say, £15 to agree or extend an approved overdraft than to pay extortionate charges for a slide into the red. Also, keep an eagle eye on your balance, paying close attention to your big bills and regular payments. Otherwise, your overdraft could get out of control and bite you on the behind.

Then again, some banks do throw you a line by providing a safety net in the form of an interest-free or even fee-free overdraft buffer. These protect you from charges and interest if you go just a few pounds into the red. Here's what's on offer from the nine bank accounts listed previously:

Overdraft buffers

Source: Moneyfacts. Note that this table doesn't include introductory offers, such as Alliance & Leicester's 12-month interest-free deal.

Finally, if you're unhappy with the cost of borrowing from your bank, don't be a willing victim. By shopping around for a Best Buy current account, you can free yourself from the tyranny of bad bank accounts. Voting with your feet could mean a saving of hundreds of pounds a year -- money which could be used to pay down your debts or to treat yourself!

More: Snap Up A Better Current Account | Don't Be Robbed By Your Bank | Passwords, PINs, Bank Accounts And Fraud