This may sound familiar to some: there is still a lot of month left at the end of the money. Because of the increased cost of living, the air for some Germans has become thinner financially towards the top. At the end of 2022, one in seven people in Germany had used an overdraft facility (Dispo) within three months, according to a representative Forsa survey commissioned by the market observation agency of the Federal Association of Consumer Organizations (vzbv). In view of these numbers, consumer advocates see a risk of over-indebtedness for German citizens and are calling for limited overdraft facilities and free debt advice.

The dangerous thing about overdraft facilities is their combination of rapid availability and high interest rates. The average interest rate for overdraft facilities in May this year was 11.22 percent, according to a comparison by Stiftung Warentest. A year ago it was 9.43 percent. What many do not know: Every day that customers claim the overdraft facility, the interest is recalculated. The longer the account is in the red, the more customers have to pay for the loan. This is based on the following formula, which can be used to calculate the interest fee: Balance x interest x overdrawn account days / 360 x 100.

The amount by which the current account can be overdrawn varies from bank customer to bank customer. As a rule, the bank determines the overdraft facility when setting up the current account contract with the customer. The framework depends on various factors such as creditworthiness or income level. Bank customers decide for themselves whether they want to use their maximum limit or voluntarily limit themselves to a smaller overdraft limit. What customers cannot determine is the overdraft rate. It is therefore always worth checking the interest rate and, if necessary, switching to a bank with better conditions. Financial institutions are now legally obliged to publish their interest rates on their website.

Anyone who overdraws their account, although the bank has not granted them an overdraft facility, must also pay overdraft interest. These are often even higher than the overdraft interest. Overdraft interest must also be paid if you exceed your overdraft facility, i.e. the current account is even deeper in the red than the overdraft facility initially agreed with the bank. Bank customers should therefore be particularly careful here.

The advantages of an overdraft facility are obvious: In the event of unforeseen expenses, consumers can get money quickly and easily without having to conclude a contract. However, credit lines can also quickly become a debt trap. For this reason, experts generally advise first saving up the required amount before fulfilling a consumer wish. In this way, buyers should avoid one or the other overdraft and save money for interest. But if the new washing machine or the new mobile phone cannot wait, an installment loan is usually the cheaper alternative to an overdraft facility.

The effective annual interest rate for an installment loan is usually significantly lower than that for an overdraft facility. The debtor agrees a fixed installment plan with the bank, which in turn gives the bank security as to when and to what extent it will repay its debts. For planned purchases, such as furniture or a car, consumers should prefer an installment loan to an overdraft facility because of the lower costs. It can even be worth taking out an installment loan to pay off your overdraft facility in one fell swoop – depending on how long it would otherwise take for the bank customer to get their account back into the black.

In some exceptional situations, an overdraft facility can be useful. Anyone who has to buy groceries about a day before their salary and has to overdraw their account can use the flexibility of the overdraft facility as an emergency solution. But that should not become a habit either. If it does happen regularly, consumers should check their monthly income and expenses to avoid high overdraft interest in the future. In addition, it can help to reduce or even completely abolish your overdraft facility in consultation with the bank. In this way, customers are not even tempted to regularly overdraw their account – and have a better chance of escaping an eternal overdraft debt spiral.

This article first appeared here at Capital.