FOOL'S EYE VIEW
Getting Rid Of Expensive Overdrafts

By Jane Mack (TMFJane)
May 22, 2002

A few days ago someone on our Debt board asked how he could get rid of the £1,200 overdraft that had been part of the fixtures and fittings of his life ever since he left university 12 years ago.

He commented:

Like I said earlier, the debt just seems to be always there! It's been like this since 1990. I really don't know how much I've paid in interest and bank charges in that time!

It's often quite hard to work out how much you pay in interest not least because banks have a habit of telling you the monthly percentage rate rather than the annual percentage rate (APR) and that makes a big psychological difference. For example, your bank statement may say that you are paying 1.41% for your overdraft but that seemingly small number translates into a colossal 18.3% a year.

Note that they don't use the monthly rate when they want you to save with them. After all, an interest rate of 4.5% looks so much better than 0.36% a month, doesn't it?

Just as an experiment I phoned the call centres of the big four banks to ask what their interest rate was for an authorised overdraft. All but one immediately told me the monthly rate. I had to actually ask what that meant annually and in two cases they even had to go and look it up because they've been so conditioned into only revealing the monthly figure. When I asked for the savings rate – guess what – I was given the annual rate!

The thing all of us need to remember about any form of borrowing is that the interest payments we make are simply the reverse of getting an interest rate on savings. And the easiest way to compare the two is to use either the monthly rate or the annual rate in both cases. Don't allow yourself to be blindsided just because it suits the banks to use different numbers for different products.

Now, since the overdraft rates of the big four banks range from 15.6% to 18.3%, we'll use an assumed APR of 17% to show that our Fool with the permanent £1,200 overdraft may have been paying as much as £204 a year in interest. This adds up to nearly £2,500 over the last 12 years! So he's paid twice as much as the loan in interest and he still owes the capital sum. And, remember, if he's had to pay any extra charges for, say, going over the authorised overdraft limit or even for the privilege of having an overdraft, then he'll have had to pay rather more than that.

So, if you've got an overdraft, get rid of it as soon as possible.

One way of dealing with it is to pay it off with a personal loan. Rates for personal loans are usually around half of those for overdrafts so, at the very least, you can take comfort from the fact that you're turning your debt into a much cheaper one. Alternatively, set yourself a target of not maxxing out the limit by say, £50 a month. Then phone up the bank and ask them to reduce the overdraft by that amount. Do exactly the same the following month and keep going until eventually you are back down to zero.

If you really can't stop yourself from maxxing out your overdraft limit each month then try transferring a set amount in a separate savings account over a period of months until you reach the equivalent of the overdraft – and then just pay it off with those savings. It's not the most efficient way of doing it but it might be the only way you can manage it.

Incidentally, if £1,200 had been invested in the stock market in December 1990, it would have grown to £4,000 by the beginning of this year. The stock market grew at 11.5% a year over this time period. It makes you think, doesn't it?

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