Overdraft or Personal Loan: Which to Use and What Each Costs

An overdraft and a personal loan are both borrowing, but they behave in opposite ways. An overdraft is a limit attached to your current account that you draw on as needed, and it is repayable on demand: a bank can ask for the whole amount back in one go if it chooses to¹. A personal loan pays you a lump sum that you repay in fixed monthly instalments over an agreed term.

The cost gap is the reason people ask the question. Interest rates from banks and building societies on their overdrafts range from 19% to 40% or more¹, and MoneyHelper puts the daily interest on a current account overdraft at up to 40%². Overdrafts are a very expensive way to borrow money because of those high interest rates³. A loan is usually cheaper for a balance you intend to carry for months, but it commits you to repayments whether or not your circumstances change.

The choice usually comes down to time. An overdraft suits a short gap before payday that you clear quickly. A loan suits a planned spend you want to spread over a fixed period. What follows sets out how each works, what each costs, what happens when you go over an overdraft limit, and where to get free help if the borrowing stops being temporary.

Overdraft or personal loan: how each one works

An overdraft is a type of loan that often has interest, borrowed through your current account¹. You agree a limit with your bank in advance and can spend up to that limit¹. Interest on all overdrafts is charged at a single annual interest rate (APR), which makes charges easier to compare between accounts¹. You only pay interest on the overdraft money you use, not on the whole limit⁶.

A personal loan works differently. You borrow a fixed sum and repay it in instalments over a set term, so the debt has an end date and a predictable monthly cost. The overdraft has neither. It is repayable on demand, which means a bank can ask you to pay the whole amount back in one go if it chooses to¹. That single feature is what separates the two products most sharply for a consumer.

There is a middle option worth knowing about. Running credit or flex credit works in a similar way to a bank overdraft: borrowers are given a limit they can draw on as and when they need to, provided they pay at least the interest off each month⁷. That structure sits between the two, with a limit like an overdraft but a repayment expectation like a loan.

The regulator has also standardised how arranged overdrafts are priced. The rate of interest that applies to any given balance of arranged overdraft on a personal current account must either be zero or the same as the rate that applies to any other balance on that account⁸. In practice that means one rate applies across the whole arranged overdraft, rather than a tiered scale that charges more the deeper you go.

Arranged and unarranged overdrafts: what changes when you go over your limit

An authorised overdraft is arranged in advance: you agree a limit with your bank and can spend money up to that limit¹. An unauthorised overdraft happens when you spend more than you have in your bank account without agreeing it in advance, including going over the limit of an authorised overdraft¹. These are also known as unplanned or unarranged overdrafts¹.

The rules changed in 2020. Rates must now be calculated as a percentage of the amount borrowed, and fixed fees and charges were banned⁹. For personal current accounts, banks and building societies can no longer charge more for an unauthorised overdraft than for an authorised one⁴. That removed the old structure of daily or monthly unarranged overdraft charges that could dwarf the amount borrowed.

What remains is interest. If you overdraw from your account, the bank will charge you interest on a daily basis and can ask that the overdraft is cleared on demand¹⁰. There are usually fees or interest if you spend more than you have in your account, including if there is not enough to cover a Direct Debit or standing order¹¹. In Northern Ireland the position is similar: you may have to pay a penalty charge and a high rate of interest, and your bank may also charge for sending a reminder letter and for Direct Debits or cheques put through the account⁶.

What each one costs you

Overdraft costs are driven by the rate and the time you stay in the red. MoneyHelper's range of 19% to 40% or more covers the market as a whole¹, and credit union current accounts offer access to borrowing using an overdraft, normally with daily interest up to 42.6%¹³. The Bank of England notes that certain types of borrowing, such as overdrafts, revolving credit on your credit card and payday loans, charge higher interest¹⁴.

Because interest is charged daily on the amount you actually use, a small overdrawn balance cleared within days costs little in absolute terms. The same balance left for a year costs far more. Experian's illustration puts £100 overdrawn for a full year at £50 at 50% EAR¹⁵. That is the shape of the cost: modest for a short gap, substantial over months.

Personal loan costs work on the opposite principle. The rate is fixed at the outset and the total cost of credit is set by the rate and the term, so you know the full cost before you sign. The trade-off is commitment: you owe the instalments whether or not you still need the money, and paying a loan early can trigger an early repayment charge depending on the lender's terms.

Interest-free overdrafts for students

Student and graduate accounts are the main place where an overdraft is genuinely cheap, because the overdraft is interest-free up to a limit. These limits are set by each bank and change with the market, so the figure that matters is the one on the account you are considering.

Graduate accounts taper. The overdraft limit goes down every 12 months¹⁷, which means the interest-free cushion shrinks year by year after university. A graduate who has come to rely on the overdraft during study can find the cost arrives suddenly when the limit drops below what they are using.

There is a wider protection worth knowing about. During the coronavirus period the FCA set out that, in the case of an arranged overdraft with a limit of £500 or below, the entire balance should be interest-free, and no interest should be payable in respect of up to £500 of the balance of the arranged overdraft for customers in difficulties who asked for it¹⁸. That was temporary guidance for a specific period, not a permanent entitlement, but it shows how the interest-free element of an overdraft is a term the bank sets rather than a right.

If you hold an interest-free overdraft with the same bank as other debts, there is a practical point about which to clear first. If the overdraft is interest-free, you could treat credit debts to the same bank as priorities so that you keep the overdraft, because if the bank starts charging interest your overdraft could increase very quickly¹⁹.

Which fits your situation: short-term gap or planned spend

The dividing line is whether the borrowing has a natural end date. Overdrafts are meant for short-term borrowing⁴, and they can be OK for bridging a gap but are not suitable for long-term borrowing because you will typically be charged interest⁹. If the money is needed for a few days until a payment lands, an overdraft does the job without a credit application.

If the money is for something planned, a loan matches the shape of the need. A budgeting loan, for example, can be used to spread the cost of things you need but cannot afford²⁰, and a short-term advance is a loan whose repayments are taken from benefit payments while waiting for a decision on a benefit claim²¹. Both are structured products with a defined repayment path, which is what a planned spend needs.

There is also a cost point about arranging the overdraft properly. You will be charged much less if you agree the overdraft beforehand²². Staying inside an agreed limit avoids the penalty charge and high rate that can follow an unarranged position⁶.

Relying on your overdraft month after month

Repeat use is the pattern the regulator watches for. In 2016, customers using an overdraft every month borrowed 81% of all overdraft lending and paid 69% of all arranged, unarranged and refused payment fees²⁴. A small group of customers carried most of the cost.

The FCA's rules on repeat use require firms to identify repeat overdraft users who are in financial difficulty and provide support and/or forbearance to address and resolve the situation²⁵. The guidance was updated on 26 June 2026, and the options a firm could identify include advice on budgeting and money management, forbearance and other support such as reducing or waiving interest and other charges, refinancing to an alternative credit agreement on more favourable terms, or agreeing staged reductions in the overdraft limit and balance⁵. A firm may also reduce the credit limit or suspend or remove the overdraft facility where doing so would not cause financial hardship⁵.

Your bank can also act on its own initiative. It can decide to cancel or lower your overdraft limit at any time, though it must warn you, and this may be more likely if you keep going over your limit¹⁵. Lenders could agree to reduce the overdraft limit over time or stop interest and charges for a while²⁶. If you are worse off after the April 2020 changes, contacting your bank might lead it to reduce or waive interest, offer a continuation of overdraft borrowing at the current rate of interest, or agree a repayment programme possibly including a personal loan¹.

More than half of StepChange's clients have overdraft debt²⁷, and the charity has called on banks to do more to help their clients out of their arranged overdrafts in an affordable way²⁷. Going into your overdraft every month may be a sign that you need free, expert debt advice²⁶.

Can I use a personal loan to pay off my overdraft?

Yes, and it is one of the standard routes out. One option is to repay the balance using credit with a lower interest rate, such as a balance transfer to a credit card or an affordable loan²⁶. That converts a repayable-on-demand debt into a scheduled one, which removes the risk of the bank asking for the whole balance at once.

The trade-off is that you are replacing flexible borrowing with a fixed commitment. A loan taken over a long term to clear a modest overdraft can cost more in total interest than the overdraft would have, even at a lower rate, because you pay interest on the full sum for the whole term. The comparison that matters is the total cost of credit, not the headline rate.

There is also a credit file effect to weigh. Current accounts with overdrafts appear on your credit report, and successive applications in a short space of time could negatively affect your score²⁸. Applying for a loan while also switching current accounts concentrates several credit searches into one period.

If you are switching current accounts while overdrawn, the mechanics matter. If the switch covers what you owe, the funds will be sent to your old bank and you will owe the overdraft balance on the new account instead. If it is a lower amount, or you cannot get one, you will need to arrange to pay off the remainder separately before you can switch or close your old account²⁹. There is more on this in switching while overdrawn.

Where to get help if borrowing is getting out of hand

Overdrafts are non-priority debts, alongside credit cards, bank loans and money borrowed from friends and family³⁰. That matters because it shapes what a creditor can do and how a debt solution treats the balance. Credit cards, unsecured loans, store cards and unsecured overdrafts are usually non-priority debts³¹.

If a debt is not dealt with, a creditor can apply to the court for a third party debt order. The kinds of debts that may end up with a creditor trying to get a third party debt order include money owed on personal loans, credit cards, overdrafts or hire purchase agreements³². That is the point at which an overdraft stops being a banking arrangement and becomes a court matter.

Free, independent help exists and it does not cost anything. StepChange runs an online debt advice tool and can be contacted for advice on your circumstances³³. National Debtline and Citizens Advice give free advice too, and MoneyHelper is the government-backed service. If a life change such as a job loss, a bereavement or a relationship breakdown has pushed the borrowing up, the advice is to get debt advice as soon as possible³⁴.

There are also safer alternatives to borrowing from family or friends, which include credit union loans, using an authorised overdraft, loans or help from a local authority, a wage advance from your employer, and a budgeting loan or advance from the DWP if you receive benefits³⁵. If the overdraft has become the thing you live on rather than a gap you bridge, the options are debt advice, a repayment arrangement with the bank, or a switch to an account without an overdraft facility²⁶.