Grasp the lifeline out of the sea of red

Millions of us pay far higher rates of interest than we need to on our bank overdrafts. Melanie Bien shows how to get a better deal

Being in the red might seem just a part of everyday life for the close on 19 million bank customers in Britain who use the overdraft facility on their current account. But rather than just accept their indebted status, many of these people should question why they are paying so much for the privilege of borrowing money.

Being in the red might seem just a part of everyday life for the close on 19 million bank customers in Britain who use the overdraft facility on their current account. But rather than just accept their indebted status, many of these people should question why they are paying so much for the privilege of borrowing money.

While there are some low overdraft rates on the market, 70 per cent of those in the red bank with one of the "big four", according to research from Alliance & Leicester (A&L). As these banks – Barclays, Lloyds TSB, NatWest and HSBC – typically charge around 18 per cent for an authorised overdraft, being overdrawn is costing the UK public more than £190m a year. And for an unauthorised overdraft, charges are as high as 33.8 per cent.

Part of the problem, says A&L, is that 42 per cent of bank customers don't realise they can move their overdraft somewhere else. They think that because they are overdrawn, they must stay with that bank and can't shop around for a cheaper deal.

"As our research shows, despite many people using their overdraft facility to manage the ups and downs in their finances, they are needlessly paying higher rates of interest," says Simon Ripton, manager of current accounts at A&L. "Unlike mortgages, loans and credit cards, people do not shop around for the best deals on their current accounts and wrongly think they are locked in if they are overdrawn. This is costing them dear."

With a third of current account customers not even knowing how much they are charged for being overdrawn, it could be time to review your facility. If you bank with one of the big four, you will almost certainly get a cheaper deal elsewhere. New Premier current account customers at A&L, for example, are being offered a 0 per cent overdraft for 12 months, which reverts to 6.9 per cent on both authorised and unauthorised overdrafts after that. To open an account, you must be over 21 and credit the account with at least £500 a month.

"A 0 per cent rate is a great way of managing debt," says Donna Bradshaw, director of independent financial adviser Fiona Price & Partners. "I would advise consumers to make full use of that 0 per cent period by building up savings elsewhere so they are actually making money."

The cash you would otherwise have had to use to meet the monthly interest payments, she suggests, could either be invested in a mini cash individual savings account or put towards your mortgage if you have an offset deal. However, it is important that you can still get your hands on the cash at the end of the 0 per cent period in order to reduce your debt.

"Just make sure you are in a position to pay off the debt when it is no longer free – although the rate it reverts to [6.9 per cent] is pretty attractive as well," adds Ms Bradshaw.

Alternatively, if you simply leave the money you would have paid in interest on the overdraft in an A&L Premier account, it would only take around a year to wipe out a £1,000 overdraft transferred from a NatWest current account, where the rate of interest is 17.8 per cent.

As the competition for current account customers hots up, several banks are giving the big four a run for their money. Some of the new accounts allow you to choose between a good interest rate on balances in credit or low interest on overdrafts, suiting people who are likely to stay in the black as well as those who spend more time in the red.

Abbey National charges 14.7 per cent on authorised overdrafts if you opt for 3 per cent interest on balances. But if you are rarely in credit, you can choose a lower overdraft rate of 8.7 per cent, which means you get no interest on balances.

Some of the best overdraft rates are online, with Intelligent Finance and Smile charging 8.39 per cent and 9.9 per cent respectively.

Halifax charges 8.9 per cent on overdrafts, while First Direct and Nationwide levy 9.9 per cent. All these accounts require you to pay in at least £1,000 a month.

If you go only slightly overdrawn each month – say by a couple of hundred pounds – many banks offer interest-free deals up to a certain amount. For example, Smilemore, a current account from Smile, offers a £260 interest-free overdraft. But beware: you have to pay £6 a month for the account. So unless you use the other features, such as free worldwide family travel insurance, it might not be worth your while. Internet bank Cahoot, on the other hand, has a £250 interest-free overdraft with no additional charges.

It is easier than ever to switch accounts, so there is no need to put up with high overdraft charges. But if you do switch, it is also worth trying to reduce the debt itself. Barclays recommends that customers keep unsecured debt below 12 per cent of their gross income.

If your debts exceed this, consider seeking guidance on how to bring them down – perhaps by contacting your local Citizens Advice Bureau.