Overdrafts Explained: Why They're One of the Most Expensive Ways to Borrow

Overdrafts feel like a minor, convenient safety net built into your current account - but since 2020 reforms changed how they’re priced, they’ve quietly become one of the more expensive ways to borrow, often more costly than a credit card for the same amount.

How overdraft pricing changed in 2020

Before April 2020, overdrafts used a confusing mix of daily fees, monthly fees, and different rates for arranged versus unarranged borrowing, making it genuinely difficult to compare the true cost across providers. Since then, the FCA has required banks to charge a single, simple annual interest rate (APR) for arranged overdrafts, with no separate daily or flat fees layered on top - a change intended to make the true cost more transparent and comparable.

Why the resulting rates are higher than many people expect

Following this reform, many banks’ representative overdraft APRs settled in the 35-40% range - considerably higher than typical credit card APRs, and much higher than most personal loan rates. This is a direct consequence of the pricing simplification: removing the ability to charge numerous smaller fees meant the underlying interest rate itself needed to reflect the full cost of the facility.

Why an overdraft can be more expensive than a credit card for the same amount

A £500 overdraft balance at 39.9% APR costs considerably more in interest over a year than the same £500 on a typical credit card at a lower APR, let alone a 0% balance transfer or promotional credit card offer (see our dedicated article on these). Because overdrafts feel like a natural extension of your current account rather than a distinct credit product, this cost comparison is easy to overlook.

Arranged vs unarranged overdrafts

• Arranged overdraft: agreed in advance with your bank, up to a set limit, at the bank’s standard overdraft APR.
• Unarranged overdraft: going beyond your agreed limit (or having no agreed overdraft at all) without prior arrangement - this can trigger additional charges and, in some cases, a higher effective cost, alongside the risk of declined payments if the bank refuses to extend further unarranged borrowing.

Practical alternatives worth comparing

• A 0% purchase credit card, if available to you, for planned short-term borrowing - typically far cheaper than relying on an overdraft for the same period.
• A personal loan, for larger, planned amounts needed over a longer period - usually carries a considerably lower APR than an overdraft for equivalent borrowing.
• A credit union loan, which can offer lower rates than mainstream overdrafts or high-cost credit for members, particularly for smaller amounts.
• Some banks offer a small interest-free buffer within their overdraft facility (commonly £250-£500, varying by provider) - worth checking your specific bank’s terms, since using only this buffer can avoid interest entirely for modest, short-term borrowing.

If you’re relying on an overdraft regularly

An overdraft that’s used briefly and cleared quickly is a genuinely different situation from one that’s persistently at or near its limit month after month - the latter is a sign the underlying budget isn’t balancing, and addressing that (see our Budgeting series for various approaches) is likely to save considerably more than optimising which type of credit is used to cover the gap. If the underlying debt already feels unmanageable rather than just a monthly gap, it’s worth understanding the difference between a Debt Management Plan and an IVA before things escalate further.

The bottom line

Overdraft APRs, simplified since 2020 reforms, now sit meaningfully higher than many other forms of consumer credit for the same amount - checking your bank’s actual overdraft APR, and comparing it against alternatives like a 0% credit card or personal loan, is worth doing before assuming an overdraft is the cheapest or most convenient option by default.