Whether you need to apply for a mortgage, other credit, or are just interested, we look at how does an overdraft affect your credit score.
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When you open a bank account, you’ll usually be given the choice of an attached overdraft. It might seem like common sense to add an overdraft to your account – but the money-savvy among us will think before saying yes.
Before entering into any kind of credit agreement, it’s important to understand the effect that an overdraft can have on your overall credit score. If you’re wondering, does overdraft affect credit score? then you’re in the right place!
Read on for more information about overdrafts and their effects on your credit rating.
What are overdrafts?
An overdraft simply means credit in your account, which allows you to borrow money from your current account.
You will enter into an overdraft if you spend more money than you have in your account. If you make a purchase of £50 but only have £10 in your account, you’ll be in an overdraft of £40.
Different types of overdraft
A lot of current accounts offer authorised overdrafts. This allows you to borrow money within a certain limit that is agreed between you and your bank.
Depending on the terms of your overdraft, you may have to pay fees and interest on the amount that you borrow. While a student overdraft may have lower fees (or no fees whatsoever), other types of current accounts may charge a high-interest rate.
An unauthorised overdraft, on the other hand, is when you go into the negative of your bank account without an agreed overdraft in place, or if you exceed your agreed overdraft limit.
Fees and interest will typically be charged on an authorised overdraft. This will be much higher than an arrange overdraft.
Reasons for using an overdraft
Alhough not everyone needs to use an overdraft, they can be a good option in some situations.
As long as you fully understand the terms of the borrowing agreement, you may want to enter into an arranged overdraft for one of these reasons:
If you’re paid monthly
If you receive your income in a single monthly lump sum, ensuring all of your payments go out on time can be a nightmare, especially if payday falls later in the month than your rent or mortgage payments.
An overdraft can help you to make sure that your important bills are paid on time, by tiding you over until payday. Before deciding to get an overdraft, you must ensure that you will be able to pay off what you owe each month.
Most of us don’t have much money stashed away for emergencies. If you’re faced with an unprecedented expense – like a high vet’s bill or unexpected moving costs – an overdraft can provide a safety net. In the meantime, look to build up an emergency fund.
As a short term solution
In a similar way, an overdraft can be used to help you through temporary financial difficulty. If you lose your job and need a buffer while you find a new one, going into an overdraft is an option. Although, it is more expensive than other types of borrowing.
Overdrafts are not designed for long term use – so you must pay your overdraft off as quickly as you can.
Find out the difference between a bank and building society
Overdrafts and your credit
Now you understand how overdrafts work, we can look at how they can affect a borrowers’ credit rating. Read on for everything you need to know about overdrafts and credit, from credit history information to mortgages.
Do overdrafts show up on credit history?
Overdrafts show up on credit reports as a form of debt. If your overdraft isn’t in use, it will be displayed as a balance of zero (showing that you’re not in debt with your overdraft).
The amount of your overdraft, and the amount you use it, will also be displayed on your report.
If you’re clearing your overdraft by the end of each month, there’s a chance that your overdraft usage won’t show up in your recorded credit history. Reference agencies only receive information from your bank monthly, and if you’re not in your overdraft on this specific day, it may be missed.
Do overdrafts impact credit scores?
Arranged overdrafts don’t usually impact average credit scores significantly, as long as you don’t exceed the borrowing limit or make payments that are unable to come out.
If you go over your set limit on a regular basis, though, your credit score will be negatively affected.
Will reducing your overdraft improve your credit?
The best way to show lenders that you’re a reliable borrower is to pay off your overdraft. This could mean reducing your overdraft gradually over time or simply not using the overdraft on your bank account.
While going into an unauthorised overdraft reflects badly on your financial situation, reducing your overdraft (and paying it off entirely – take a look at the best way to clear overdraft) indicates that you’re in a stable position.
Can overdrafts affect mortgages?
When you submit a mortgage application, the bank will closely check your finances. You’ll have to provide bank statements from at least the last three months. So if you’re using your overdraft regularly, this will show up to the lender.
Although eligibility will vary between lenders, being in a non-authorised overdraft, being close to your limit or being unable to reduce your debt indicates financial difficulty. This will make you less attractive to lenders, and may even cause you to be declined for some mortgage plans.
If you’re experiencing short-term financial issues, dipping into your overdraft can provide a much-needed bit of cash to tide you over. As long as you understand the implications of having an authorised overdraft, it’s fine to use your current account’s overdraft as it’s intended to be used.
If you use your overdraft regularly, remember that it can have an impact on your overall credit score. Though going into a non-agreed overdraft will have a larger negative impact, even an authorised one can impact your rating, particularly if you’ve borrowed a large amount that you’re unable to pay back. If you are using your overdraft regularly, you may want to put in an irresponsible lending complaint with your bank.
When you submit an application for credit (whether that’s for a mortgage, personal loan, credit card or even phone contract), potential lenders will view your credit report and history. They’ll see your overdraft information – including its amount and how much you’ve used. This will inform a lenders’ decision.
Everyone wants a good credit rating, but if you’re in a situation where credit score is very important (like if you’re trying to buy a home), we’d recommend avoiding overdrafts altogether. If you’ve already got one, reducing or paying it off completely will help to indicate your reliability.
An overdraft can hurt your credit score. This can cause issues when you try to lend in the future like when submitting a mortgage application.
Every time you use your overdraft, you risk it showing up on your credit record.
If you can avoid it, you shouldn’t use your overdraft every month. Paying off your overdraft gradually shows your financial responsibility to potential lenders.
Because using your overdraft shows up on your credit report, it can affect your mortgage eligibility.
Different lenders have different policies, so you could be rejected by one mortgage provider but accepted by another. The impact your overdraft has depends on your usage – how much you’ve borrowed on your account and how regularly you pay it off.