We look at how an overdraft affects your credit score, whether you need to apply for a mortgage or other loans, or you’re just curious. So here’s a guide to overdrafts and credit scores.
Overdrafts Defined
An overdraft is just a credit balance in your account that permits you to borrow funds from your checking account.
If you spend more money than you have in your account, you will incur an overdraft. You’ll find yourself in an overdraft of £40 if you spend £50 but only have £10 in your account.
Banks and building societies make authorized overdrafts available on many current accounts. This permits you to borrow money up to a particular amount that you and your bank agree upon.
They may require you to pay fees and interest on the amount borrowed, depending on the terms of your overdraft. While a student overdraft may have cheaper fees (or none at all), other types of current accounts may levy a high rate of interest.
Overdrafts and Credit Scores – Unarranged Overdrafts
An unauthorised overdraft, on the other hand, occurs when your bank account balance falls below zero without an agreed-upon overdraft in place. Or when you exceed an agreed-upon overdraft limit.
An allowed overdraft is usually subject to fees and interest. This will be far more expensive than a pre-arranged overdraft.
Overdraft Uses
What could an individual use an overdraft for? Perhaps, if an employer pays you a lump amount every month, and you need to make sure all of your bills are paid on time.
By tying you over until payday, an overdraft can assist you ensure that your key bills are paid on schedule. You must ensure that you will be able to pay off your debt each month before applying for an overdraft.
Most of us don’t have much money set aside for unexpected expenses.
You can utilise an overdraftin a similar way to assist you get through a temporary financial crisis. Going into an overdraft is an option if you lose your job and need a cushion while you look for a new one.
Overdrafts And Credit Scores
Credit reports list overdrafts as a type of debt on credit reports. If your overdraft isn’t in use, it will show a zero balance (indicating that you aren’t in debt with your overdraft).
Your report shows the amount of your overdraft as well as how much you use it.
If you pay up your overdraft by the end of the month, it’s possible that the overdraft won’t be noted in your credit history. Your bank only sends information to reference agencies once a month, so if you’re not in your overdraft on that day, it could be missed.
Will It Affect My Rating?
As long as you don’t go over your borrowing limit or make payments that aren’t able to be made, arranged overdrafts don’t have a big impact on your credit score.
However, if you consistently exceed your credit limit, your credit score will suffer as a result.
Paying up your overdraft is the best approach to demonstrate to lenders that you’re a trustworthy borrower. This could include gradually reducing your overdraft or just not using your bank account’s overdraft.
While entering into an unauthorised overdraft is negative for your credit, reducing your overdraft (and eventually paying it off – see the best approach to clear an overdraft) shows that you’re in good financial shape.
