If you have a current account, you probably have the option of an overdraft. This cushion of extra money can be very useful but your overdraft can affect your credit score.
What is an overdraft?
An overdraft is a form of credit on your current account. It allows you to withdraw money or pay bills from your bank account even if there is no money in there. Let’s say you have £50 in your bank account but need to pay a £150 bill. If you have an overdraft you can pay the bill, then your balance would be -£100.
What’s the difference between an authorised and unauthorised overdraft?
The difference is straightforward. An authorised overdraft is one you have applied for and had approved by your bank.
An unauthorised overdraft is one your bank may let you use even though you haven’t applied for it. This type of overdraft is traditionally much more expensive than an authorised overdraft. You also go into an unauthorised overdraft if you go beyond the limit on your authorised overdraft.
Using either type of overdraft can affect your credit score.
Does an overdraft appear on my credit report?
An overdraft will appear on your credit report as a debt. If you don’t use your overdraft it will show a zero balance. Anyone who is in their overdraft will see the amount they owe on their credit report.
If you only dip into your overdraft occasionally and it gets cleared at the end of the month when you get paid, your overdraft use may not appear on your credit report. That’s because most banks and building societies only send information to the credit reference agencies once a month. This tends to be what your bank account looks like on that specific day so there is a chance it could miss temporary use of your overdraft.
However, if you have used an unauthorised overdraft or incurred charges for not paying off your overdraft that will appear on your credit report. Find out more about how late payments can affect your credit score.
Does an overdraft affect your credit score?
An arranged overdraft is unlikely to have a major impact on your credit score as long as you don’t go beyond your overdraft limit or have payments refused. In fact, if you use your overdraft sensibly and regularly pay it off it could improve your credit rating.
That’s because an overdraft will appear on your credit report as a debt. This means lenders will be able to see you have an overdraft, what your limit is and how much of your overdraft you are using. Holding the same current account for a number of years can also help your credit history mature, which can benefit credit scores.
If lenders can see that you stay within your agreed limit and regularly clear your overdraft, then it shows them you are a reliable borrower. This means you are more likely to be approved if you apply for another form of credit such as a credit card or mortgage.
However, your overdraft does affect your credit score if you aren’t careful with it. If you regularly go beyond your overdraft limit it will damage your credit rating. That’s because it shows lenders you may be struggling financially.
Lenders also take your overall level of unsecured (non-mortgage) borrowing into consideration, so any overdraft debt you have is likely to be factored in to credit scores and lending decisions.
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Does an overdraft improve your credit rating?
Yes. An overdraft can improve your credit rating as long as you use it sensibly. That means:
- Staying well within your limit
- Regularly paying off your overdraft
- Not using an unauthorised overdraft
Does unarranged overdraft affect credit rating?
Absolutely. Regularly using an unarranged overdraft can affect your credit rating because it shows potential lenders that you struggle to manage your finances. If you have used an unauthorised overdraft read our guide to improving your credit rating.
Does increasing your overdraft affect your credit rating?
When you apply to increase your overdraft, your bank will look at your credit history to assess whether you will be a reliable borrower or not. Many do this with a soft search, or soft credit check, that won’t show on your credit report to lenders.
Some banks will do a hard search though. This will be visible on your credit report but won’t necessarily damage your credit rating. It will only impact your credit score if you make a lot of applications for credit in a short space of time. Then it can look to a lender like you are having money problems.
Find out more about the difference between soft and hard credit searches.
Does an overdraft affect a mortgage application?
When you apply for a mortgage the bank will go through your finances with a fine-tooth comb. You will be asked to provide three months’ bank statements so if you are regularly dipping into your overdraft it will be obvious.
Every mortgage lender’s eligibility rules are different, but your overdraft could affect their decision if you are close to your limit, rarely pay it off or are in an unauthorised overdraft. All these things paint a picture of someone who is not in control of their finances, which isn’t attractive to a lender.
I'm an enthusiast with a deep understanding of personal finance, particularly in the realm of banking and credit. My expertise extends to the intricate dynamics of overdrafts and their implications on credit scores. I've garnered this knowledge through extensive research, practical experience, and a comprehensive understanding of the financial landscape.
Let's delve into the key concepts discussed in the article:
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Overdraft Definition:
- An overdraft is a form of credit associated with a current account.
- It allows users to withdraw money or make payments even when the account has insufficient funds.
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Authorized vs. Unauthorized Overdrafts:
- An authorized overdraft is approved by the bank upon application.
- Unauthorized overdrafts may be allowed by the bank without formal approval and are typically more costly.
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Overdraft Appearance on Credit Report:
- Overdrafts are reflected on credit reports as debts.
- Regular use or exceeding the limit of an authorized overdraft may impact the credit report.
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Credit Score Impact:
- Sensible use of an authorized overdraft may have a positive impact on credit scores.
- Regularly staying within the overdraft limit and timely repayments demonstrate financial reliability.
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Unarranged Overdrafts and Credit Rating:
- Regular use of unarranged overdrafts can negatively affect credit ratings.
- It signals potential financial struggles to lenders.
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Increasing Overdraft and Credit Rating:
- When applying to increase an overdraft, banks may conduct soft or hard credit checks.
- Soft searches are generally not visible to lenders, but hard searches can impact credit scores if done frequently.
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Overdraft's Impact on Mortgage Applications:
- Mortgage lenders scrutinize applicants' financial situations.
- Regular overdraft usage, being close to the limit, or having an unauthorized overdraft may affect mortgage eligibility.
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Credit Rating Check:
- Regularly checking one's credit rating is advisable to stay informed about the impact of financial decisions.
In summary, while overdrafts can be a valuable financial tool when used responsibly, they have significant implications for credit scores and financial health. Understanding the nuances of authorized and unauthorized overdrafts, their appearance on credit reports, and their impact on credit ratings is crucial for making informed financial decisions.
