Overdraft charges are more expensive than payday loans

Payday loans have attracted an enormous amount of our ire: it's hardly surprising when providers load the loans with such outlandish interest rate charges. However, while the worst excesses of the payday loan sector have faced a clampdown, overdrafts have been subjected to far less interference. Now a study by Which? has revealed that some overdrafts have become more expensive than payday loans.

Payday loans remain shockingly poor deals, but back in January 2015, they faced a cap on charges - so they could no longer charge more that 0.8% per day of the amount borrowed - and if borrowers do not repay on time they can't be charged more than £15 in default charges. In addition, the total cost is capped at 100% of the original sum. Meanwhile, there are no such caps on overdrafts.

Which? compared the cost of borrowing £100 for 28 days and found that charges at some high street banks were as much as £90 - up to four times higher than the maximum charges of £22.40 on a payday loan.

The charges could be even higher if interest payments or possible unpaid item fees are included, or the money is borrowed over two bank monthly charging periods - because the maximum charge relates to the bank's monthly charging period and not the borrowing period.

It reflects the experience of Gillian Guy, Chief Executive of Citizens Advice, who said: "High overdraft charges can quickly push people into cycles of dangerous debt. We help people with 55,000 overdraft debt problems a year - in some cases consumers are paying more in overdraft charges than they would for a payday loan."

What next?

Following its review of retail banking in the UK, the Competition and Markets Authority (CMA) has published a number of remedies to tackle overdraft charges, including a requirement for banks to have a monthly maximum charge for unarranged overdraft usage.

Citizens Advice has welcomed this. Guy said: "It's good that the CMA is proposing a monthly maximum charge on unarranged overdrafts. This recommendation builds on progress made earlier this year to roll out fee free basic bank accounts for people in financial difficulty."

However, Which? says it is unlikely to make much of a difference, because banks typically already put caps on charges and it does not address the overall level of fees.

Which? is calling for unarranged overdraft charges to be set at the same level as arranged overdraft charges and for the FCA to review overdraft charges in the context of other forms of credit and crackdown on punitive fees.

Alex Neill, Director of Policy and Campaigns, said: "The regulator has shown it's prepared to take tough action to stamp out unscrupulous practices in the payday loans market, and must now tackle punitive unarranged overdraft charges that cause significant harm to some of the most vulnerable customers."

The good news is that the government is taking an interest in this area now too. On Thursday, Andrew Tyrie, Chairman of the Treasury Committee, announced he had written to the Chief Executives of 13 banks, asking them to provide information about their charges – including paid and unpaid – on both authorised and unauthorised overdrafts, for each type of personal banking account they offer.

He said: "Consumers need to know what they are being charged for their bank accounts, especially their overdrafts. At the moment they often struggle to find out. So I have written to the banks in an effort to obtain some of this information and, in particular, to see what steps the banks take when a customer falls into an unarranged overdraft."

Protect yourself

Of course, as always, we cannot expect things to move at a rapid pace in government, so if there is any risk at all of you needing to use an overdraft, it's essential to understand the fees and charges in place for arranged and unarranged overdrafts.

If you will end up paying over-the-odds, it's worth considering moving to a bank with a more favourable rate, or considering using a credit card as a cushion for any month you overspend in - as long as this won't tempt you to more overspending.

As MoneySuperMarket points out, someone with an authorised overdraft of £1,500 being charged a typical interest rate of 17.5 per cent (EAR) would be paying out 72p per day, which adds up to £263 in interest in a year. However, clearing the £1,500 with Virgin Money's money transfer credit card (which offers 32 months at zero per cent on money transfers subject to a 1.69 per cent fee) would only incur a fee of £25.35, saving more than £235 in interest over the year.

In the long-term, if you regularly find yourself using an overdraft, it's also essential to go back to your monthly budget. The effort of getting your income and outgoings to balance won't be a pleasant one, but it's far better than getting things wrong on a regular basis and paying the price of sky-high fees and charges.