Students should go for an overdraft that lasts the course

Freshers week is coming up and, next to an iPod or a laptop, setting up a student bank account may seem low on the list of priorities for new undergraduates. But the wrong deal could cost hundreds of pounds in expensive borrowing – just when cash is tight.

"Banks use freebies to draw in students, which can often detract from the core features," says Kevin Mountford at the price-comparison site Moneysupermarket.com. "In a lot of cases, the overdraft element will prove far more relevant."

Interest-free authorised overdrafts are fairly low on student accounts in the first year – usually around £1,000. Most banks operate a stepped borrowing policy, allowing your limit to increase as your studies progress – generally up to £2,000 by the third year. The best interest-free overdraft is the Halifax's £3,000 limit, which remains consistent every year. Royal Bank of Scotland (RBS) is close behind with a maximum of £2,750 throughout your course.

But stray over the limit and the costs shoot up, even if your extra borrowing has been agreed. Abbey's authorised overdraft fee is 9.9 per cent; bust the new limit and the rate is 28.7 per cent, plus a monthly charge of £25. Lloyds TSB will charge 8 per cent interest if you stay within your agreed borrowing limits, and 29.8 per cent if you stray, plus £15 a month. Clydesdale, RBS and Yorkshire Bank charge some 20 per cent a year on unauthorised borrowing.

Most freebies and incentives, such as a few cinema tickets or 10 per cent off CDs, can be easily brushed off, especially as National Union of Students entitlements will give you access to a range of discounts. But a lump sum is enticing, and Abbey and Lloyds TSB offer cash to draw you in when you open an account.

However, there is no such thing as a free lunch, warns Michelle Slade at financial analyst Moneyfacts: "The cash incentive of up to £100 from Lloyds TSB may also sound appealing, but £80 of this requires you to recommend four friends."

By far the most rewarding gimmick on offer is the five-year student railcard offered by NatWest, especially if your university is at the other end of the country from family and friends.

"Most banks will also offer you a student credit card, with a limit typically around £500," adds Ms Slade. "But however tempting a credit card can be, treat it with caution. With no regular income, even a few hundred pounds can prove a struggle to repay, especially when the interest rates tend to be high."

Once you have your degree, the banks will want their money back. "Unfortunately, the perks of 0 per cent overdrafts don't last forever and graduating can bring a financial reality check," says Sean Gardner at comparison site MoneyExpert.com.

"Graduate accounts do the opposite to student accounts and reduce the interest-free overdraft limit from the first year onwards. The levels start around £2,000, dropping to nothing at all by the end of the second or third year. Both Abbey and NatWest offer decent accounts, with free overdrafts dropping from £2,000 in the first year to £500 in the third."

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