How to get out of debt and your overdraft

Higher-rate taxpayers are more likely to become overdrawn than basic-rate taxpayers, new research has found.

Around 14 per cent of higher-rate and additional rate taxpayers fall ‘into the red’ for at least half the month compared to just 9 per cent of basic-rate taxpayers, data from Hargreaves Lansdown claims.

The survey of  2,000 people asked about how regularly they were either overdrawn, or owing more on a credit card than they held in their bank account.

Someone going into their overdraft by £500 all month every month for 10 years would have to stump up £1,663 in interest over the course of a decade, assuming a 39.9% interest rate.

‘Going into debt isn’t necessarily a reflection of how wealthy you are,’ said Sarah Coles, personal finance analyst at Hargreaves Lansdown.

‘Instead, it’s about the balance between what you have coming in and what you have going out.

‘If you live in a bigger, more expensive home, have children in private school, and buy your essentials from Waitrose, the things you consider to be absolute essentials will cost several times that of someone in a smaller property who shops at Aldi.’

The study also found that young people aged 18-34 are more than twice as likely to be overdrawn compared with those aged 55 and over.

‘Young people are most likely to dip into the red for at least two weeks each month, with one in every 10 of 18-34 year olds admitting to this, up from 7 per cent last year,’ said Coles.

‘The rise reflects the fact that young people have been hit particularly hard when it came to job losses and furlough during the past year.’

In terms of geography, Londoners are more likely to fall ‘into the red’ than any other UK region.

11 per cent of the capital’s populace spend at least half the month overdrawn compared to just two per cent of people who live in the north-east.

Londoners are most likely to be in debt:  11 per cent spend at least half the month in the red versus 2 per cent of people who live in the north-east.

Londoners are most likely to be in debt:  11 per cent spend at least half the month in the red versus 2 per cent of people who live in the north-east.

The research also found that households with children under 18 living at home are twice as likely to be in red than households with no under 18s present.

One in 10 households with under 18s at home were found to be overdrawn for at least two weeks each month compared to five per cent of those without any young to look after.

For those families with as many as four children at home, 28 per cent reported being in the red for at least two weeks each month.

‘London is a notoriously expensive place to live, so it’s hardly surprising that 11 per cent of those who live in the capital need a helping hand from their overdraft or credit card to get through each month,’ said Coles.

‘Likewise parents with children under 18 living at home face the higher running costs of a bigger home, along with constant financial demands from their offspring, so it’s no surprise they’re twice as likely to be in the red for at least two weeks a month.’

However, some results from the study might come as more of a surprise.

Whilst being single is often considered more expensive than being coupled up, with cohabitees typically able to share certain expenses, it was found that couples are more likely to be in debt than singletons.

‘Some trends come from a false sense of security,’ said Coles.

‘This may be because couples feel more secure with two incomes to fall back on, so they’re less vigilant about avoiding debts.’

The research also showed that gender has no bearing on the likelihood of falling into the red.

While FCA statistics show that men are more likely to hold credit cards or loans and women are more likely to use retail credit or high-cost loans, overall, these tend to balance one another out.

The survey showed that 7 per cent of both men and women go into the red for at least half of every month.

What are the costs of being overdrawn?

Whilst dipping into your overdraft on rare occasions is manageable, it can spiral out of control and become an expensive issue if you begin relying on it.

Going into your overdraft by £500 all month every month for 10 years would cost £1,663 in interest over the course of a decade, assuming a 39.9 per cent interest rate, according to Hargreaves Lansdown.

Being in the red by £500 for three weeks each month would cost £1,159 in interest over a decade and for a £500 overdraft for two weeks of the month, the cost would equate to £773.

One in 10 young people are in the red for at least half of every month compared to 4 per cent of those aged 55 and over.

One in 10 young people are in the red for at least half of every month compared to 4 per cent of those aged 55 and over. 

‘If you are always going into the red every month, there’s no getting away from the fact that you’re spending more money than you have coming in,’ said Andrew Hagger personal finance expert at MoneyComms.

‘If that’s the case, it’s worth sitting down and spending half an hour going through your bank and card statements to see where your money is going and looking for ways to cut things out or cut back so you don’t have to rely on an expensive overdraft.

‘Maybe consider switching your energy deal or car and home insurance for cheaper deals – that’s a good start.’

What other dangers come from being overdrawn?

Other than having to pay interest, there are other potentially damaging consequences that can arise from being frequently overdrawn.

When it comes to applying for a mortgage, lender’s will typically want to see your latest bank statements to help them assess your credit worthiness and therefore, anyone deemed to be reliant on their overdraft may be considered too great a risk.

‘Lenders assessing a consumer for a mortgage may turn them down if they discover they are living in excess in their overdraft, particularly if they have a large facility or fall in an unarranged limit,’ said Rachel Springall, personal finance expert at Moneyfacts.

‘Being in the red can also upset one’s mindset as it can have a negative impact on whether someone will continue to use it as they are already ‘in the red anyway’.

What can you do to reduce the costs of falling into the red?

If you are someone who frequently dips into red, then choosing a current account that will subject you to lower interest rates on your overdraft might be wise.

First Direct for example, offer a current account where your first £250 of overdraft is interest free.

Whilst many banks subject customers to arranged overdraft interest rates of 39.90 per cent, some are much less pricey – Starling Bank for example offers an arranged overdraft of 15 per cent.

Another option is to consider using a credit card for some of your existing current account spending.

‘Even if you don’t pay your statement balance off in full the interest rate will be around 20 per cent, so likely half what you’re paying on overdraft,’ said Hagger.

Alternatively, if you want to pay your overdraft off in full you could consider a 0 per cent balance transfer credit card.

A balance transfer credit card allows customers to pay off debts by transferring the entire debt over to the new card, often with the promise of 0 per cent interest for a fixed period of time.

‘This allows you to switch the money from your card straight to your bank account,’ said Hagger, ‘you’ll find there is a one-off fee of around 4 per cent of the balance transferred but it still remains a cost effective way to sort out your current account.’

‘Try the MBNA 0 per cent money transfer for up to 18 months with a 3.49 per cent one off fee or the Tesco Credit Card 12 months 0 per cent with a 3.99 per cent fee.’

How can you stop falling into the red?

Using an overdraft or relying on a credit card should be as a last resort and whilst its convenient to use, ultimately the best outcome is to avoid becoming dependant on it.

‘There are different ways to budget but a quick and easy way is to use Money dashboard, a free mobile app where consumers can connect their accounts and clearly see their balance across cards, savings and their current accounts,’ said Springall.

‘Using this could help someone move funds to prevent being charged for using their overdraft and also work out where they may be overspending each month and what they could rein in.’

Six steps to get out of the red

1. Work out what you owe

Don’t ignore your debts and stick your head in the sand. The first thing to do is jot down what you owe. 

2. Decide how much you can pay

Make a budget and prioritise your spending 

3. Apply for a 0% balance transfer card

This allows you to transfer an existing balance to a new card where you won’t have to pay any interest for an introductory period 

4. Pay off the most expensive debts first

If you have more than one credit card or loan, you may need to meet minimum repayments, but then you need to prioritise paying off the one with the highest interest rate. 

5. Speak to your creditors if necessary.

Don’t be shy about picking up the phone and speaking to your bank or credit card provider. They may agree to a repayment plan, which could allow you more time to pay off your debts. 

6. Get expert advice

Debt charities like StepChange and National Debtline give free, confidential advice, including creating a free debt management plan and contacting your creditors to come up with affordable repayments.  

Some links in this article may be affiliate links. If you click on them we may earn a small commission. That helps us fund This Is Money, and keep it free to use. We do not write articles to promote products. We do not allow any commercial relationship to affect our editorial independence.