Why a Permanent Overdraft Is Not a Good Idea

Most current account holders in Germany also have an overdraft facility. How high it is depends on financial circumstances, but also on personal preference. In principle, the overdraft is convenient: it is always available, does not need to be applied for before use – and it is used gladly. Sometimes a permanent account balance within the overdraft limit develops, which is consequently expensive, annoying and also dangerous. This article outlines the problems and solutions.

Figure 1: Those who permanently live in their overdraft pay unnecessarily high interest. There are indeed alternatives. Image source: @ Markus Spiske / Unsplash.com

 

The overdraft facility is expensive

Banks charge quite well for the constant provision of the overdraft facility. The costs are not noticeable without using it, but once the account balance goes into the negative, it gets expensive. A test revealed that the average overdraft interest rates are just under 10 percent per year. Of course, overdraft interest is rather marginal if the account occasionally dips slightly into the negative for a few days. However, if it is used on a permanent basis, it becomes expensive and problematic:

• Ongoing costs – overdraft interest is charged for every day in the negative. This means the costs for the overdraft increase daily.
• Increase – it often happens that things start with a smaller negative amount, which gradually increases over the months. This causes costs to rise again.
• Repayment – in principle, repaying the overdraft is quite simple. Since it is offset monthly with every incoming payment, only certain amounts need to be withheld each month so that the negative balance decreases. However, ›in principle‹ is not ›in practice‹ and many people end up in the permanent overdraft trap.

Those who only use the provided credit occasionally for a few days – for example, to quickly fill up with petrol before their salary arrives – naturally have no problem. However, anyone who mostly sees red numbers when looking at their account and has to calculate how much money is still available up to the overdraft limit should quickly find a solution. Debt restructuring through a pure installment loan would be the best and cheaper solution in this case. By now, there are installment loans specifically designed for the purpose of settling overdrafts.

 

The alternative: installment loan for purchases

There are generally two reasons why the overdraft is used. One is that unplanned costs arose in a month that had to be covered, causing the account to go into the negative. The other reason is purchases that were paid for via the overdraft. In this case, an installment loan would be a much more sensible solution:

• Costs – the fees for installment loans are always lower than those of the overdraft facility. In addition, the amounts can now be chosen quite freely, with flat-rate loan offers often providing the best terms.
• When to use it – as soon as a larger purchase or an expensive repair is coming up, an installment loan is worthwhile. The application process today with digital offerings takes around 48 hours, so the waiting time is not too long.
• Larger purchases – if larger purchases are planned, an installment loan is always the best choice. The consumer only needs to estimate in advance how much money is really needed.

Installment loans should of course always be compared with one another, and when comparing, it is not only the costs that matter, but also the other terms and conditions. Free special or even full early repayments should be possible, and safeguards such as payment breaks are also useful features.

As already mentioned, an installment loan could also be used to repay the overdraft facility. In some cases, this loan can also be combined with purchases, i.e. issued at a higher amount. Loan installments will of course apply, but customers ultimately save on interest and still have the overdraft available in genuine emergencies.

 

The alternative to the permanent overdraft: the revolving credit

The permanent overdraft often occurs simply because it is so convenient. A revolving credit is not yet worthwhile when the account is still deeply in the red, but anyone who has finally laboriously balanced their overdraft or carried out a debt restructuring can make use of this form of credit:

• What is it? – the customer arranges a loan with a bank. However, this loan is not paid out into the customer's account, but transferred to a special credit account. This can then be linked to the bank account. If the customer needs money, they transfer part of the amount or the full amount to the account.
• Costs and conditions – at first glance, the interest rates seem slightly higher, but they are barely a consideration. Because they too do not apply to the total amount, but only to the amount drawn down.
• Repayment – this varies contractually. Often the withdrawn amount can be repaid at any time, although there are sometimes deadlines. Example: 500.00 euros were taken out; they must be settled within three months of withdrawal. For full withdrawals, the deadlines are of course longer.

But why is the revolving credit suitable as a remedy against the permanent overdraft? As already mentioned, the overdraft is often used instinctively. "Oh, I can still buy that product, my salary is coming soon." The money is there after all. With a revolving credit, however, an intermediate step is added between seeing and buying: the required amount must be transferred. This raises the threshold for impulse purchases and not infrequently the salary is waited for first, or it is considered whether there is not another solution. Added to this are of course the significantly lower interest rates and the protection against permanently moving within the overdraft and having less and less room up to the overdraft limit.

Figure 2: It is easy to calculate: alternatives to the overdraft facility are frequently considerably cheaper. Image source: @ Kelly Sikkema / Unsplash.com

 

Conclusion – get out of the overdraft quickly

Admittedly, when the account is in overdraft, the sight is depressing. The numbers are red, there is a big minus sign in front of them and incoming payments seem to disappear into a void, as they are automatically offset against the overdraft. But it is precisely the costs of the overdraft and the danger of sliding ever deeper into the red that call for alternatives. Installment loans are always more sensible for purchases, and they are equally suitable for settling larger overdraft amounts. Once the account is in the black, it is worth looking into revolving credit. It is a very good alternative and offers a natural barrier: the transfer that must be carried out beforehand.

 

How do you manage your finances? Do you have further tips for avoiding the permanent overdraft? Why not write a comment.

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