Credit Building > What to do if you're stuck living in overdraft?

What to do if you're stuck living in overdraft?

Wollit Team4 minute read · Updated 3rd July 2024

If you find yourself relying on your overdraft a bit too much, take it as a sign that you may need to do something to improve your financial situation. Living in an overdraft can be costly and make it hard to save money or achieve your financial goals.

Here are some steps you can take to get out of an overdraft and avoid using it in the future.

Understand your overdraft costs

The first step is to understand how much your overdraft is costing you. Most banks in the UK charge interest on overdrafts, with rates typically ranging from 35% to 40% EAR (Effective Annual Rate). This means that if you borrow £1,000 for a year, you could end up paying £350 to £400 in interest alone.

To get a better idea of your overdraft costs, use your bank's overdraft calculator to estimate the interest you'll pay based on your average overdraft balance and the number of days you're overdrawn each month. This will help you understand the true cost of using your overdraft and motivate you to reduce using it.

Create a budget

Creating a budget is essential for getting out of an overdraft – and staying out.

Start by tracking your income and expenses for a month to get a clear picture of where your money is going. Then, look for areas where you can cut back on spending, such as reducing discretionary expenses like eating out or entertainment.

Once you have a budget in place, stick to it as closely as possible. You may need to make some tough choices, but it will be worth it in the long run.

Here are some of the best budgeting apps that you can use to stay on track:

Emma: Uses AI to analyse your finances and provide tailored tips for saving money.
HyperJar: Divides your money into separate digital "jars" for different purposes, and allows you to set spending limits and restrictions on each jar.
Plum: Analyses your income and spending patterns to calculate what you can affordably save, then automatically transfers small amounts to a separate Plum savings account.

Increase your income

If cutting expenses isn't enough to get you out of your overdraft, consider ways to increase your income. This could involve taking on a part-time job, freelancing, or asking for a raise at your current job. Even a small increase in income can make a big difference when you're trying to pay off debt.

Prioritise overdraft repayment

When you have extra money available, make it a priority to pay off your overdraft. Consider setting up automatic transfers from your current account to a savings account to ensure that you're consistently making progress. Even if you can only afford to pay a small amount each month, it will add up over time.

Avoid triggering unarranged overdraft fees

If you accidentally go over your arranged overdraft limit, you may be charged additional fees by your bank. To avoid these fees, keep a close eye on your balance and set up low balance alerts to be notified when you're getting close to your limit. If you do accidentally go over, contact your bank immediately to explain the situation and see if they can waive the fees.

Consider consolidating your debt

If you have multiple debts, such as credit cards or personal loans, besides your overdraft, consider consolidating them into a single loan with a lower interest rate. This can simplify your repayment process and potentially save you money on interest charges over time.

However, be sure to read the terms of any consolidation loan carefully to make sure that it really is a better deal than your current debts paid separately. Most people who consolidate debt do it to manage them better or to take advantage of zero-interest repayment periods. You might want to make sure that you’re not accidentally adding even more debt.

Make a plan to avoid relying on your overdraft in the future

Once you've paid off your overdraft, make a plan to avoid relying on it in the future. This may involve building up an emergency fund to cover unexpected expenses, setting aside money each month for irregular expenses like car repairs or medical bills, and sticking to your budget.

What are the long-term effects of living in overdraft on my credit score?

Living in an overdraft in the UK can actually have both positive and negative long-term effects on your credit score.

Here’s how:

Using an arranged overdraft sensibly and repaying it regularly can show lenders that you can manage debt well, and it can actually improve your credit score over time.
However, regularly going over your overdraft limit or having unauthorised overdrafts can actually lower your credit rating, as it signals lenders that you might be struggling.

In other words, the best way to use an overdraft is to stay within your limit and make regular repayments to avoid hurting your credit score.

However, if you’re counting on overdraft as a credit-building tool, you might want to look elsewhere. Overdraft repayment terms are usually short, and once you go beyond them, the interest rates are high – higher, in fact, than most credit cards and loans.

A much safer and more affordable credit-building alternative is a specialised credit-building app.

One such app is Wollit. Wollit is an app available both on Android and iOS, and it works by reporting a fixed-fee monthly subscription as a loan repayment to all three credit reference agencies.

Building your credit history through an overdraft requires you to first buy things on overdraft and then repay it as soon as possible. With Wollit, you only need to pay a fixed monthly subscription. Wollit then reports this subscription as a loan repayment to the credit reference agencies.

This directly builds your credit history and improves your credit score – while keeping you safe from high interest charges, unauthorised overdrafts, or the risk of more debt.

More importantly, as your credit score increases, you’ll eventually become eligible for credit cards with longer repayment terms and much higher credit limits than even the best overdraft.

Plus, by using a credit-building app like Wollit, the impact of a negative factor like an unauthorised overdraft will fade away and your new history of timely repayments will be far more important for the credit agencies and lenders as well.