The overdraft
An overdraft is the most convenient loan there is, and one of the most expensive. For a few days it's fine. As a permanent state it costs you real money every year.
An arranged overdraft lets you take your current account below zero up to a set limit. The bank sets that limit, often at two or three months' salary. You don't have to apply or sign anything. The money is simply there.
That convenience is what makes it risky. In Germany the interest rate is often 10 to 14 percent a year, and higher at some banks. A normal personal loan usually costs a fraction of that.
What that means in euros
Aylin has been around 2,000 euros overdrawn for a year. Her bank charges 12 percent. That costs her about 240 euros in interest a year, 20 euros every month, for nothing in return.
If she paid off the 2,000 euros with a personal loan at 6 percent over twelve months, she would pay about 65 euros in interest in total. After that she'd be debt free. With the overdraft there's no end in sight as long as nothing changes.
How people slide into a permanent overdraft
It usually starts with one bigger expense, a car repair for example. The account goes into the red, the next salary evens it out, but only for a few days. After a few months the minus has become normal. The salary just fills last month's hole.
The best protection is an emergency fund. With three months of spending in a savings account you pay the garage from there and never touch the overdraft.
How to get out again
- Check your average overdraft over the last three months. That's your real debt.
- If you can, pay it off with a cheaper personal loan, then have the overdraft limit lowered or removed.
- Build a small buffer at the same time so the next surprise bill doesn't start it all over.
As long as you're in your overdraft, investing hardly pays. Almost no investment reliably earns 12 percent. Paying down the debt earns it for sure.
Besides the arranged overdraft there's the unarranged one. It applies when you go beyond your limit or have no overdraft agreed at all. Many banks charge several percentage points more for that.
Interest is usually charged every quarter and taken from the account. If the account is then even further in the red, you pay interest on interest in the next quarter. That's compound interest working against you.
In Germany a rule in the Civil Code protects you. If you use the overdraft for six months without a break and on average more than 75 percent of the limit, the bank has to offer you a meeting about cheaper alternatives. The EU Consumer Credit Directive creates similar duties in other member states.
If you already have several loans, instalment purchases and a maxed out overdraft, don't just refinance. A free debt advice service, run by consumer centres or charities in most countries, first helps you get an overview. Austria and Switzerland have comparable state recognised services.
Summary
- An overdraft often costs 10 to 14 percent a year and is meant for a few days.
- A permanent minus is paid off with a cheaper loan, then the limit is lowered.
- An emergency fund is the best protection against sliding into it at all.
- While you're overdrawn, paying down beats investing.
Did you get it?
What does a permanent 2,000 euro overdraft cost at 12 percent?
About 240 euros in interest a year, roughly 20 euros a month.
Why is an overdraft so bad as a long term solution?
It's far more expensive than a personal loan and never ends. Each salary only fills the old hole.
What does a German bank have to do if you use your overdraft heavily for a long time?
After six months at over 75 percent usage on average, it has to offer you advice on cheaper alternatives.
Sources and further reading
- German Civil Code, § 504a (advice duty for persistent overdraft, German). View source ↗
- Directive (EU) 2023/2225 on credit agreements for consumers. View source ↗
- Verbraucherzentrale, overdraft interest (German). View source ↗
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