Debt Advice Handbook (13th edition)Chapter 5: Types of debt Bank overdraft
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Bank overdraft
A bank overdraft is a type of revolving credit (see here). The bank allows a customer with a current account to overdraw on the account up to a certain amount. Repayment of the overdraft is made as money is paid into the account. Overdrafts may be ‘authorised’ (ie, if the client has a prior arrangement with the bank to overdraw) or ‘unauthorised’ – ie, if the client has no prior arrangement, but the bank nevertheless allows the account to go overdrawn.
**Alert: With effect from 2 October 2020, the FCA published updated guidance regarding its expectations of how banks should support clients after 31 October 2020. The FCA recognised that clients who had already benefitted from such support but remained in payment difficulties as well as those newly affected by coronavirus would need tailored support. The FCA expects banks to provide forbearance that is appropriate to the individual circumstances of the client, including doing one or more of the following:
    •reducing or waiving interest;
    •refinancing – ie, transferring the overdraft debt to an alternative credit product on more favourable terms – subject to the repayments being affordable and the client’s borrowing not being significantly increased; or
    •agreeing a repayment plan – ie, agreeing a programme of staged reductions in the overdraft limit and balance.
Reducing or waiving interest will be appropriate for many clients, particularly if s/he:
    •requires immediate assistance in response to an unexpected change in the client’s financial circumstances; or
    •has a temporary difficulty that is likely to be resolved in a relatively short period – eg, the client is suffering temporary ill-health; or
    •needs immediate short-term assistance while s/he obtains debt advice or while appropriate longer-term forbearance is being considered and put in place.
Banks should not reduce the client’s overdraft limit or suspend to remove the facility while a client is receiving help under this guidance if that reduction, suspension or removal would cause financial hardship to the client.**
The legal position
Bank overdrafts are regulated under the Consumer Credit Act 1974, provided the credit is for no more than £25,000 (if granted before 6 April 2008) or £15,000 (if granted before 1 May 1998). It does not matter whether the overdraft is authorised or unauthorised. No written agreement is required for an unauthorised overdraft. If the agreement for an authorised overdraft was made before 1 February 2011, no written agreement is required. If the credit is granted on or after 6 April 2008, the agreement is regulated regardless of the amount, unless it is exempt – eg, it is for business purposes and provides credit of more than £25,000 (see here). An overdraft may be either secured or unsecured.
Special features
Interest is charged, usually on a daily basis, and repayment in full can be requested at any time. When the agreed overdraft limit is reached, cheques and transfers drawn against the account are usually stopped.
If the overdraft is not approved by the bank or the limit is exceeded, a higher rate of interest is usually charged and additional service charges may be made at the bank’s discretion. Even if an overdraft is within its agreed limit, the bank may decide to apply additional charges.
When a customer has both a current account with overdraft facilities and a loan account with the same bank, it is common for banks to require payments to the personal loan account to be made from the current account. This may be done even if there are no funds in the current account, so that the higher overdraft rate of interest applies to the payments made to the personal loan account.
Similarly, if someone has her/his wages paid directly into a current account, they are always applied initially to reduce any overdraft on that account, even if debts such as mortgage arrears should be given a higher priority for repayment.
Emergency action may, therefore, be needed to ensure income is not swallowed up as it becomes available. It may be necessary to open a current account with another bank so that wages can be paid into the new account or, if this is not possible, exercise the ’first right of appropriation’ and earmark the funds (see here).
Note: banks can transfer money from a sole account to a joint account in order to pay a joint debt but not the other way around (but see below).1For a discussion on various aspects of bank transfers, see J Wilson, ‘Consultancy Corner’, Adviser 107 and 108. See also report of a complaint to the Financial Ombudsman Service reported in Ombudsman News 40 (Adviser 107 abstracts). In multiple debt cases, the bank should recognise the pro rata principle when considering a payment arrangement and that priority debts should take precedence over non-priority debts, which is what the bank’s debt is likely to be unless it is secured on the client’s home.
It may be possible to challenge any charges added to the account (see here).
Since 18 December 2019, banks are required by the Financial Conduct Authority (FCA) to draw up and implement policies and procedures to identify customers who are showing signs of financial strain or are in financial difficulty, and implement a strategy to reduce repeat overdraft use.
The FCA has also introduced new rules for overdraft charges, which come into effect on 6 April 2020, that will:
    •prohibit banks from charging higher prices for unarranged overdrafts than for arranged overdrafts;
    •abolish the right to charge fixed daily/monthly fees for overdraft use;
    •require banks to price overdrafts by a simple annual interest rate and to advertise overdraft prices with an annual percentage rate (APR), to assist customers to compare overdrafts with other products.2FCA Handbook, CONC 5C and 5D. See also G McLean, ‘FCA rein in unfair overdraft charges’, Quarterly Account 53, IMA
There is evidence that some banks have increased the interest rates on their overdrafts in anticipation of these rule changes.
 
Offsetting credits against debts
Although the bank can offset any credits received against any debt owed to it, the FCA’s Banking: Conduct of Business Sourcebook (which has applied to retail banking since 1 November 2009) says that banks must consider the interests of their customers and must treat customers who are in financial difficulty fairly. The FCA says that if a bank is considering using set-off on a client’s account, it should:3FCA Handbook, Banking: Conduct of Business Sourcebook 5.1.3AG, 5.1.3BG and 5.1.4G
    •consider each case and assess how much money needs to be left in the account to meet priority debts and essential living expenses, and refrain from offsetting against that amount;
    •usually provide a refund if it becomes apparent that money taken in set-off was intended for priority debts or essential living expenses (or justify why it considers it is not fair to do so);
    •not use set-off on money that it knows, or should know, was received by the customer from a government department, local authority or the NHS and was intended for a specific purpose (eg, for healthcare) or if a third party is entitled to it.4FCAHandbook, Banking: Conduct of Business Sourcebook, 5.1.3A and 5.1.3B
The Financial Ombudsman Service also expects banks to have given their customers a fair and sufficient opportunity to discuss the situation and repay the outstanding debt before resorting to their right to set off funds.5See Financial Ombudsman Service decision in Ombudsman News 84 (Adviser 140 abstracts) Some bank’s terms and conditions purport to give the bank a right of set-off in respect od debts solely owed by only one of the joint account holders. The FCA has declined to express a view on either the enforceability or fairness of such terms.6See FCA Handbook, Banking: Conduct of Business Sourcebook 4.1.4A(2)(a)(ii) and (5)
 
1     For a discussion on various aspects of bank transfers, see J Wilson, ‘Consultancy Corner’, Adviser 107 and 108. See also report of a complaint to the Financial Ombudsman Service reported in Ombudsman News 40 (Adviser 107 abstracts). »
2     FCA Handbook, CONC 5C and 5D. See also G McLean, ‘FCA rein in unfair overdraft charges’, Quarterly Account 53, IMA  »
3     FCA Handbook, Banking: Conduct of Business Sourcebook 5.1.3AG, 5.1.3BG and 5.1.4G »
4     FCAHandbook, Banking: Conduct of Business Sourcebook, 5.1.3A and 5.1.3B »
5     See Financial Ombudsman Service decision in Ombudsman News 84 (Adviser 140 abstracts) »
6     See FCA Handbook, Banking: Conduct of Business Sourcebook 4.1.4A(2)(a)(ii) and (5) »
Checklist for action
Advisers should take the following action.
    •Consider whether emergency action is necessary (see Chapter 8).
    •Advise the client to open a new bank account at a bank with which s/he does not have any debts.
    •Check liability, including the enforceability of the agreement under the Consumer Credit Act 1974.
    •If the bank has resorted to offsetting funds, check that it has complied with the guidance and codes of practice.
    •Assist the client to choose a strategy from Chapter 9 as, if the debt is unsecured, it is a non-priority debt. If it is secured, it is a priority debt. See Chapter 8.