An overdraft can be a useful tool. They'll provide a cash buffer between paydays and are reassuring if you’re ever running low. However, an overdraft can affect your credit score if you don’t manage it properly.
What is an overdraft?
An overdraft is when your bank lets you borrow money from your current account when you don’t have any in it.
For example, if you have £100 in your account and you spend £200, your balance will show as -£100. When money goes back into your account, it will automatically start paying off the overdraft. So, if £100 goes back into your account, your balance will be £0.
There are sometimes extra charges or fees for going into your overdraft, but this varies depending on your bank.
What’s the difference between an arranged and unarranged overdraft?
An arranged overdraft is when your bank agrees to provide you with an overdraft up to a certain amount. This means if your balance goes below zero, you can continue spending until you hit the amount set by your bank. There can be interest fees and charges for using an arranged overdraft.
An unarranged overdraft is when your balance goes beyond zero and into the minus without an overdraft already in place. Unarranged also includes if you exceed your overdraft limit agreed with your lender. You’ll most likely be charged fees and interest for this as well.
Before April 2020, banks would often charge higher rates for unarranged overdrafts, but since then banks now must charge a single APR, so customers can compare accounts more easily.
Will using an overdraft affect my credit score?
Having an overdraft is unlikely to have a major impact on your score. The instances where an overdraft would impact your credit score negatively is:
- if you use an unarranged overdraft regularly
- if access to an unarranged overdraft has been rejected
- if you borrow an amount that takes you over your agreed overdraft limit
- if you fail to pay off your overdraft.
Overdrafts are documented as debts on your credit report. This means that any potential lender will be aware that you have an overdraft. They'll know what your overdraft limit is, how often you use it, how much you spend when you use it and how often you pay it back.
Paying off your overdraft regularly shows lenders that you are likely to be a reliable borrower. If you manage your overdraft responsibly, your credit rating should improve.
If you ever found yourself in a position that meant you wouldn’t be able to pay your off your overdraft, your debt may be passed on to a debt collection agency. If this were to happen, it would negatively affect your credit score.
Will increasing my overdraft affect my credit score?
When you apply to increase your overdraft, your bank will either do a soft credit check or a hard credit check.
A soft credit check is when a company looks at a small amount of information on your credit report to determine whether you’d be a reliable borrower. A soft credit check would not be recorded on your credit report.
A hard check is when a company does an in-depth examination of your credit history, which would be recorded on your credit report, and can decrease your score.
When it comes to using an overdraft, it can be useful, but you shouldn’t rely on it for cash as they can become difficult to pay off and you could end up paying a lot in fees and interest if you use it enough.
Disclaimer: All information and links are correct at the time of publishing.