Why are overdrafts so expensive?

An overdraft is short-term unsecured borrowing that you can enter without applying at the moment you use it, and it is priced for exactly that risk and convenience.

Arranged overdrafts are pre-agreed limits. In the UK these now carry a single simple annual interest rate — typically somewhere around 30–40% EAR at high street banks — following a regulatory change that banned the previous mixture of daily fees, monthly fees and tiered charges. That reform made pricing transparent, but for many customers it also made the headline rate look far worse than the old fee structure had, because the true cost had previously been obscured.

Unarranged overdrafts — going beyond your limit or overdrawing without an arrangement — were historically far worse, with fixed daily charges that could make a small shortfall astonishingly costly. The same reform required arranged and unarranged borrowing to be priced at the same rate, which removed the most punitive charges.

Why the rate is high at all:

It is unsecured, with no asset backing it.

It is available instantly and repayable on demand, so the bank cannot plan around it.

Users are, on average, higher risk. Persistent overdraft use correlates strongly with financial difficulty, and the pricing reflects the resulting default rates.

The amounts are small and the administration is not, so fixed costs are spread over little principal.

Why it still feels invisible: overdraft interest accrues daily on the amount overdrawn and is usually charged monthly, so there is no moment of borrowing to notice — you simply have less each month.

A credit card at 25% APR, a credit union loan, or an arranged personal loan are often cheaper for anything lasting more than a few days.