Just as we get ready to launch our radical new overdraft replacement (SmartCredit - the borrowing half of ChipX), the FCA have announced they want to put an end to ridiculous and complicated overdraft fees.
In a stroke of luck, we’ve been taking a very close look at just how much overdrafts are ripping you off.
The overdraft - a complicated beast 😕
In the scheme of things, overdrafts look like one of the cheapest ways to flexibly borrow money. But, in practice overdrafts are often both expensive and complicated.
The first thing to wrap your head around is that there are two kinds of overdraft:
Arranged: AKA the ‘good’ kind of overdraft, where your bank has given you permission to borrow money. This is normally a formal credit agreement, with set interest charges and fees.
Unarranged: the ‘bad’ kind of overdraft, where you spend more than you have in your bank account, without asking your bank about it first (it’s debatable about whether unauthorised overdrafts should exist!). These come with all kinds of extra fees and charges and are best avoided!
To make life easy, let’s concentrate on arranged overdrafts.
Overdrafts - what do they actually cost?
Finding out the true cost of your overdraft takes a bit of sleuthing through some terms and conditions documents and fine print. Everyone’s favourite pastime.
This is because, unlike credit cards, loans or mortgages, there’s no universal rule about advertising the cost of overdrafts upfront. Banks don’t need to show an APR (Annualised Percentage Rate) - a single rate showing how much it would cost over a year, including any fees.
So, whilst banks aren’t necessarily doing anything wrong, they don’t exactly make things easy for you.
Ludicrously complicated cost plans
For starters there’s two ways banks charge overdrafts:
Charge you an interest rate (called EAR - effective annualised rate - in the business), the more you borrow the more you pay.
Charge you flat fees (normally charged daily or monthly), you pay the same no matter how much you borrow.
But some banks use mad combination of the two.
For example, NatWest’s overdraft charges you 19.9% interest EAR. On the surface this seems simple enough; leave £100 in the red for a year and you’ll be charged roughly £19.
However, there’s also a sneaky £6 monthly charge for every month you’re overdrawn. So, you’d be charged £72 a year, plus paying that 19.9% interest.
Now, unless you’re really good at maths (and this isn’t even the fun kind of maths, you won’t see this on Countdown any time soon), it’s hard to work out the actual cost of the NatWest overdraft.
But if you do some fiddly mathematics, the cost works out at;
a fairly reasonable 27% APR if you’re £1,000 overdrawn
a fairly unreasonable 91.9% APR if you’re only £100 overdrawn
Even Monzo doesn’t make things easy 🚀
The flat fee method can be a bit misleading. As it costs more (much more) to borrow less.
For example even Monzo, the bank famed for their transparency, charges £0.50 a day for an overdraft, so if you were overdrawn for a month you’d pay around £15, and if you’re overdrawn all year you’d pay £182.50.
This is pretty reasonable if you’re overdrawn a large amount, but let’s say you live in your overdraft to the tune of about £100, you’d end up paying the equivalent of an annualised rate of around 180% APR, which is pretty steep!
Monzo aren’t alone using this kind of pricing plan (we don’t want to single out Monzo, we love them as much as the next FinTech savvy millennial!), it’s also used by Santander (£1 a day) and a few other big banks.
The maddest of them all 🤯
Though, Lloyds win the prize for complexity, with this mind-bending sentence:
“The daily arranged overdraft fee is 1p for every full £6 you borrow up to £1250, 1p for every further full £7 you borrow between £1250 and £2500, and then a further 1p for every full £8 you borrow over £2500.”
Ever read something that makes you feel like you’re in some hellish arithmetic test?
I’m going to be honest, I’m not going to even attempt the maths on that one just now, but the bottom line is it sounds cheap, but is actually quite expensive.
Stuck in the overdraft swamp
Not only are overdrafts hard to understand if you’re being ripped off, they’re hard to get out of.
This is something that anyone who’s ever dipped into their overdraft knows all too well.
You know, that deflating feeling of getting paid, checking your bank balance and seeing it’s only about £10 in the black, before the resignation sinks in that you’ll be overdrawn again in a matter of days.
Overdrafts have no set repayments, as usually your income goes into the same account. However, this means, there’s no fixed schedule to kill off the debt (called amortisation in the business), like you would with a loan.
So, it can be quite easy for people to ‘live’ in their overdraft and never quite escape it. As unless; a) you’re very disciplined; b) your expenses materially change; or c) you get a payrise, there’s no way you’re going to get out of your overdraft.
At risk of being melodramatic. It’s a bit like being stuck in a swamp, where the moment you struggle to lift your head above the water, you sink back into the quagmire.
We hope to shake up the overdraft market very soon
You’ll be hearing much more about SmartCredit soon.
Today we plan to soft launch SmartCredit to selected Chip users, and will be fully launching to the public later this year. Watch this space!