Overdrafts and freebies: welcome to student banking

Think carefully before choosing a lender to see you through the next few years at university. Chiara Cavaglieri offers some timely advice

Finance may not be at the forefront of students' minds as their first university term approaches, but with banks keen to lure them in, there is the potential to access huge overdrafts and some impressive freebies. Picking the right account can be tricky and making the wrong decision will have an impact on any student's financial situation.

What is a student account?

The main distinction between a standard current account and a student bank account is the interest-free overdraft. Students will typically have access to as much as £3,000 without paying any interest. But while a customer can have any number of current accounts, those in full-time education can have only one student account. So anyone hoping to snap up perks from all the banks will be disappointed.

How to pick the right account

Despite the potential for enticing freebies, the interest-free overdraft should be the focus. "The single most important thing that banks can offer you is access to money. Don't get distracted by all the freebies, particularly if they're not things you would have spent money on yourself," says Johnny Rich, editor of student website Push.co.uk.

This year, HBOS has been the most generous, with Halifax offering an interest-free overdraft of up to £3,000 for up to five years, and the Royal Bank of Scotland offering up to £2,750. However, the maximum overdraft is not always guaranteed and it will often be approved on an individual basis.

In any case, a smaller overdraft may be a more suitable budgeting tool for students concerned about having access to large sums of credit. Several high street banks tier the overdraft limit, including NatWest which has an interest-free overdraft facility starting at £1,250 in year one, then moving to £1,400 in year two, £1,600 in year three, £1,800 in year four and £2,000 in year five.

"Choosing an account where the available credit gradually builds up over the years of the course may help for those who are not used to budgeting," says Samantha Owens from Moneyfacts.co.uk.

Any students not planning to live off their overdrafts should also look at the in-credit interest rate. Many offer little or no interest at all, but Abbey's student account pays 2 per cent AER on balances up to £500 and gives you £50 cash after the first month. Even better, students going to a university that has joined the Santander Universities network can hold a Santander University account and earn an impressive 5 per cent when in credit. HSBC also pays 2 per cent in-credit interest on the first £1,000, during the first year at university.

Another factor is ease of access. Does the bank have a branch on campus? Can the account be accessed online? In terms of convenience, NatWest comes out on top with more than 50 campus branches throughout the UK and student banking managers in all Student Service branches.

The debit card offered with the account may also be a factor as some, such as Visa Electron, are not widely accepted in the UK and abroad. Others may have a lower than average withdrawal limit, which can be awkward for those wanting access to large sums from an ATM.

What about those freebies?

These bonus features vary widely from one lender to another. "Students are feeling the pinch as much as everyone else, if not more, so its key for them to look out for real opportunities to save on day-to-day things they use like travel and communications," says Phil Cook, the head of NatWest student banking.

Students planning to spend a lot of time travelling abroad may benefit more from an account offering commission-free foreign currency and travellers' cheques. The Halifax student account offers a 25 per cent discount on AA breakdown cover and 20 per cent off its Card Care card protection insurance. Alternatively, HSBC offers two years of worldwide travel insurance, but only if at least £250 in one lump sum is put into the account between August and October 2009.

NatWest's 2009 student account offers a five-year, 16-25 railcard worth £130, which is ideal for those needing to take the train to and from university, or planning to visit family regularly. Students can also snap up a starter pack for 3's pay-as-you-go mobile broadband with a 50 per cent discount and save £100 on laptops.

Lloyds TSB offers a free NUS Extra Card worth £10, savings of up to £36 on AA driving lessons, free YHA membership for one year for discounts at hostels around the world, plus 35 music downloads from eMusic.

What to watch out for

Student finances can easily become erratic, so the cost of exceeding overdraft limits is a vital component. Check the rate for both an extended and an unauthorised overdraft (one that has not been arranged with the lender). "If students feel they may need to increase their borrowing, they should look at the authorised overdraft rates and charges and also consider what they may get charged for unauthorised borrowing," says Ms Owens.

The 2009 student package from Barclays provides an interest-free overdraft facility of up to £2,000, then an authorised overdraft of up to £1,000 at a rate of 8.9 per cent EAR (equivalent annual rate). Students banking with Abbey, however, will pay 9.9 per cent EAR for borrowing after their interest-free allowance of up to £2,000.

When it comes to unauthorised overdrafts, the charges will vary greatly, but most lenders set a sky-high rate of interest and penalties to boot. Abbey, for example, charges a rather painful 28.7 per cent EAR on unauthorised overdrafts and a monthly fee of £25. Similarly, Halifax charges 24.2 per cent EAR and £28 per month. Barclays' Personal Reserve facility covers you if you go over your overdraft limit, but charges £22 for each consecutive five-day period in which you use this reserve.

What happens after graduation can also be a shock to some students. Most student accounts will automatically transfer to a graduate account or a current account. Some lenders will take away the interest-free overdraft immediately, which could pose problems for those unable to pay it off quickly.

Others will gradually reduce the overdraft limit which can offer a much easier way to pay it back without the risk of paying high interest on the debt. The Lloyds Graduate account, for example, has a tiered 0 per cent overdraft limit dropping from £2,000 for the first year after you graduate to £1,500 in year two and £1,000 in year three. The rate for going over these limits, however, is 16.8 per cent which could really sting those who need access to more credit.

"It's well worth finding out how their repayment method works. What are they going to charge and how quickly are they going to want you to pay them back?" says Mr Rich.