As the credit crunch bites and bad debts mount up, banks are fighting back by raising interest rates for borrowers. Clearly, being overdrawn is set to become even costlier...
This article was first sent to Fools as part of our 'The Good, The Bad and The Ugly' email campaign.
Recently, I started doing something that I haven't done for more than five years -- I slipped into the red. In other words, I went from having a credit balance in my current account to being overdrawn.
My bank, First Direct, provides me with a fee-free overdraft of £500, with no interest payable on the first £250. Last week, I received a letter informing me that the interest rate on borrowing over £250 was being increased from 12.9% EAR to 15.9% EAR. Put another way, my monthly interest rate was bumped up from 1.02% to 1.24%. This amounts to an overnight hike of almost a quarter (22%) in the basic cost of being in the red!
What really made me cross was that the letter informing me of this change arrived on 10 September, but the interest-rate rise took effect a month earlier on 11 August. Hence, I telephoned my bank and insisted that, rather than backdating this increase by a month, it took effect from the date that I was notified. My bank agreed, and reduced my interest charge over that month.
The rising cost of overdrafts
Of course, interest is just one of three levels of charges which applied to overdrafts. In addition, there are approved overdraft fees, which are usually charged yearly. For example, my bank charged me £50 for an extra-large overdraft limit for one year. On top of this, there are extortionate charges for going overdrawn without permission, as I warned in Is Your Overdraft An Ogre?
What's more, my latest research shows that the interest rates charged to customers who are overdrawn vary enormously. According to the September edition of Moneyfacts magazine, 35 different banks, building societies and other organisations provide personal current accounts. In total, you can choose from 98 variations on this theme, with Lloyds TSB alone offering fourteen different accounts. Talk about being spoilt for choice!
Rather than torture you by going through each of these accounts in detail, I'll cut to the chase. In the Best Buy category, Alliance & Leicester's range of current accounts deserves a mention for charging no interest on approved and unapproved overdrafts.
However, A&L does charge borrowers a monthly account fee of up to £5 in lieu of interest. (The £5 isn't charged for the first year after opening the account.) Likewise, Coventry BS charges no interest on borrowing up to £1,000. The Norwich & Peterborough BS Gold Current account also deserves a mention, as it charges a modest 7.74% EAR on authorised overdrafts.
Are you seeing red?
At the other end of the scale, it's not unusual for banks to charge several times the Bank of England base rate (currently 5% a year) for approved overdrafts. While dozens of accounts charge interest rates of more than three times base rate, some of the worst offenders include:
Current account | Approved overdraft interest rate (% AER) |
|---|---|
Bank of Ireland (NI) Clear Account Level 3 | 21.26 |
Bank of Ireland (GB) HICA | 20.45 |
Abbey Current Account (Credit Option) | 19.90 |
HSBC Bank Account | 19.90 |
Halifax (three of its four accounts) | 19.50 |
Lloyds TSB Classic | 19.30 |
NatWest Current Plus and Current Plus - Advantage Blue | 19.24 |
Royal Bank of Scotland IPCA | 19.24 |
Your rate may differ
Finally, it's worth pointing out that your overdraft interest rate may be higher or lower than the standard rate used by your bank. These days, many banks `rate for risk', using individual pricing to tailor interest rates based on personal profiles. Thus, I would urge you to find out how expensive your overdraft is today. The answer may come as something of a shock!