If you’re confused when it comes to the role overdrafts, outstanding debts and your bank balance play with your credit score, then don’t go anywhere, because we’ve explored them all.
Credit scores are something more and more of us are starting to take notice of, in no small part due to the financial crisis in 2007 which led creditors to really clamp down on who they will and won’t lend to.
There's a whole load of factors that can either boost or damage your credit score, and it’s often believed that your overdraft, outstanding debt and current bank balance are included on the list. In this blog, we’ll outline their true impact – if any.
An overdraft is a form of lending that occurs when you spend more money than you have in your current account. It’s really important to know the difference between authorised and unauthorised overdrafts because this ties in closely with credit scores, so let’s start with a whistle-stop tour of the two.
An authorised overdraft is one that can either be agreed with your bank in advance or may be automatically included with your account. Either way, your overdraft limit will be fixed.
As with any type of borrowing, you’re likely to be charged interest on any money you borrow.
This type of overdraft occurs when you spend more money than you have in your current account but haven’t agreed to an overdraft with your bank, or when you exceed your pre-agreed overdraft limit.
The fees and charges associated with an unauthorised overdraft are typically much higher than with an authorised overdraft.
Overdrafts and your credit score
The difference between the two is important because unauthorised overdraft usage is going to have a harsher impact on your credit score than authorised. This is because your credit report will show that you’ve borrowed money without permission and could suggest you’re not good at handling your expenses.
Even with an authorised overdraft, it’s important that you don’t end up reliant on it, and if you find you tend to live in your overdraft it could negatively impact your credit rating.
If you look at your credit report you’ll usually see that your overdraft is shown, but if you don’t rely on it too heavily, stay within your agreed limit and pay it off promptly, your credit score shouldn’t be affected.
Amount of debt
There’s no two ways about it, the amount of outstanding debt you have is one of the largest factors in your credit score.
The impact of credit cards on your credit score is determined by what’s called ‘credit utilisation’, and this refers to the ratio between your credit limit and your credit balance.
Confused? Let’s break this down into a language we can all understand.
Credit utilisation for beginners
So, let’s say you’ve got a credit card with a £5000 limit but you’ve only spent £150 this month. This would leave you with a low credit utilisation ratio, and this is good. That’s because your credit balance is significantly less than your available credit limit.
On the other hand, if you’ve got a credit card with a £5000 limit but you’ve spent £4750, you’d have a high credit utilisation ratio because your credit balance has nearly reached your credit limit. This could have a negative effect on your credit score.
When it comes to outstanding loans and their impact on your credit score, it’s the balance left on your loan that influences your score.
While you’ll boost your credit score with every repayment made on time and in full, generally speaking, the smaller the gap between your loan amount and the current loan balance, the worse your credit score will be – and vice versa.
It’s a common misconception that if you’ve got a healthy bank balance this will boost your credit score, but actually, your bank balance doesn’t even feature on your credit report and has no impact on your score (unless you’re in your overdraft).
This doesn’t mean the amount of money you have won’t affect any applications for credit though, because lenders will typically ask about your income when assessing your affordability. However, how much money you have or haven’t managed to save up won’t affect your credit score or ability to access credit in the future.
So, what’s the lesson here?
1. Don’t fret about your bank balance. If you’ve got a steady income and haven’t struggled with credit in the past, whether you’ve got £1 or £10,000 in your current account, it won’t affect your credit score.
2. Overdrafts aren’t necessarily a bad thing, it’s how you use them that matters. So long as you aren’t relying on your overdraft heavily or maxing out your credit limit, dipping into your overdraft here and there won’t have a big impact on your credit score.
3. Don’t use unauthorised overdrafts. If you think your bank balance might be close to £0 on the odd month, arrange an authorised overdraft with your bank just in case. You might never need it, but if you do the impact on your credit score will be much less.
4. Keeping on top of your outstanding debts is key. While we’ve said they’re the biggest factor in determining your credit score, we also know they’re unavoidable. In today’s world nearly everyone has outstanding debt in one form or another, but by staying on top of your monthly repayments and keeping a close eye on how much you spend on credit cards, you can keep the impact of existing debt on your credit score to a minimum.
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Intelligent Lending Ltd (Credit Broker). Capital One is the exclusive lender.