If you’ve ever wondered how an overdraft affects your credit score, you’re not alone. A lot of people don’t understand how this type of borrowing works and what it can do to their credit rating. It’s important to understand how everything you do affects your credit score. Especially when you ‘re trying to get your finances in order.
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What is an Overdraft?
An overdraft allows you to borrow money through your account by spending more money than you have in that account. For example, Let’s say you’ve only got £100 left in your bank account, and you pay a bill for £120 your account will be overdrawn by £20. This means you’ll be in debt to the bank by £20.
If your bank has put a block on you spending more than what’s in your account, you won’t be able to go overdrawn. So, in our example, you’d be short £20 when it comes to paying that bill.
What are the Different Types of Overdrafts?
If you’ve got a bank account, you’ll know if you’ve got the option to go overdrawn on your account. But there are two types of overdrafts you can have.
1. Authorised overdraft
This is when the bank agrees to you spending more than what you have in your bank account. When this is agreed, you’ll be given a limit up to which you spend to.
You can ask for an overdraft, or the bank may just give you one. But the main point is that, with an authorised overdraft, it’s agreed in advance of you using it.
2. Unauthorised overdraft
This is when you spend more than what’s left in your bank account, but you haven’t agreed it with the bank. This means you’re spending money you don’t have without the bank’s permission.
You might have an authorised overdraft in place, but you spend over the agreed limit. If this happens, the amount you spend over your limit is also classed as an unauthorised overdraft.
Will I be Charged for Authorised and Unauthorised Overdrafts?
Yes, there will be charges for going overdrawn. It doesn’t matter whether the overdraft is agreed or not, you’ll still be charged. This is because an overdraft is a form of debt, so the bank will charge interest on what you borrow.
In the past, banks would charge more for an unauthorised overdraft than they would for an authorised one. But since April 2020, they’re no longer allowed to do this. They can now only charge a single interest rate on all their overdrafts.
The amount of interest you’re charged can be anything from 19% to 40% or more. It’s important that you find out what interest rate your bank is going to charge you for going overdrawn.
Does an Overdraft Affect Your Credit Score?
An overdraft can affect your credit score. But it all depends on how you use it. Having an overdraft won’t have any impact if you don’t use it. But if you have got an overdraft and you use it, the table below shows you how it’ll impact your credit score.
| How you use your overdraft | How it affects your credit score |
| You stay within your agreed overdraft limit and pay it back in line with the bank’s terms. | This won’t negatively affect your credit score. It could improve your score by showing you can manage your money. |
| You go over your agreed overdraft limit. | This can damage your credit score as it looks as if you’re not managing your money. |
| You have an unauthorised overdraft. | This will damage your credit score as it shows you’re struggling to keep control of your finances. |
Does an Overdraft Appear on Your Credit Report?
Yes, if you have an active overdraft, it’ll appear on your credit history. When lenders run a credit check, they’ll be able to see the following information about your overdraft.
- How much your overdraft limit is.
- How much you go overdrawn by.
- How often you use your overdraft.
- How you manage it and pay back what you owe.
If you have an overdraft but never use it, it may not show up on your credit file. It depends on your bank.
Will Applying for an Overdraft Affect Your Credit Score?
Applying for an overdraft will influence your credit score depending on the credit check the lender does. It could be either a soft credit check or a hard credit check.
- A soft credit check is when the bank gets an overview of your credit file. They don’t see the details of your credit history. But it helps them to decide whether to give you an overdraft.
- If a soft credit check is done, you’ll see it on your own credit file, but no one else will. This means it won’t affect your credit score.
- A hard credit check means the bank can see details of your credit history. A hard credit check will leave a mark on your credit file that other lenders can see. And this will have a short term effect on your credit score.
- A hard credit check will remain on your credit file for up to 12 months. But the longer the time that passes since the hard check is done, the less impact it has on your credit score.
Is it Bad to Use Your Overdraft Every Month?
The answer to this depends on how you use your overdraft. It’s important that you treat it like a line of credit and use it wisely. That way it won’t be such a bad thing if you use it every month. Keeping within the following guidelines will help.
- Always pay off your overdraft in line with the bank’s terms.
- Try not to spend up to your agreed overdraft limit.
- Don’t go overdrawn if you haven’t got an authorised overdraft agreed in advance.
By following these points you’ll help your credit rating rather than hurt it. It’ll show lenders that you’re in control of your spending.
How Can You Keep Your Overdraft Under Control?
There are things you can do to keep your overdraft under control. Here are three top tips for you to follow.
1. Budget Your Money
It might sound like a chore but by budgeting your money you control your spending. When you can see where your money’s going you can find ways of cutting back. It’s much better to use your overdraft for emergencies rather than for everyday spending.
2. Download Your Bank’s App (if they have one)
If you have a smartphone, having your banking app on it can give you quick access to your account. You can check your bank balance before you spend. And it lets you keep an eye on where your money’s going any time of the day.
3. Set up Text Alerts for When Your Account is Running Low
Most banks give you the option of sending you a text message when your account falls below a certain amount. This is useful as you’ll be more careful with your spending when you know your account balance is low.
Will Overdrafts Stop You from Getting Loans?
How an overdraft affects your loan applications will depend on how you’ve used it. If you’ve managed your overdraft well, it’ll have a positive impact on your credit report. This could help you with your loan applications as it shows that you can manage your money well.
If you don’t manage your overdraft well and you keep spending up to or over your limit, this will hinder you. Lenders will be able to see that you haven’t been able to keep your spending under control. And this would influence their decision on whether to lend to you or what interest rate they offer you.
What Alternatives are there to Having an Overdraft?
There are other ways of borrowing money that you might prefer. Here are some options.
1. Credit Cards
These allow you to borrow money up to a limit set by the lender. The good thing about credit cards is that if you pay off your balance in full when it’s due, you pay no interest. This makes them a cheap way of borrowing money short term.
2. Short Term Loans
If you just need a small amount of money to cover an emergency, a short term loan can help. It allows you to pay back the money you borrow over a short period. Having a little longer to pay it off can help with your budgeting. And a short term loan could be cheaper than an overdraft if the interest rate is lower.
Can I Switch Bank Accounts if I’ve Got an Overdraft?
Yes, it is possible to switch bank accounts if you’ve got an overdraft. When you switch bank accounts in the UK, you use the Current Account Switching Scheme (CASS). This system transfers all your direct debits and payments to your new bank account for you.
But you’ll need to take some action if you’re using your overdraft when you want to switch.
1. Switching Bank Accounts with an Overdraft You’re Not Using
If you had an overdraft on your old bank account but weren’t using it, you don’t have to do anything. You can switch accounts without any problem. But if you want an overdraft with your new bank account, then you’d have to apply for one with them.
2. Switching Bank Accounts with an Overdraft You’re Using
If you’re overdrawn and you want to switch bank accounts, there are two options available to you.
- Ask your new bank if they’ll let you transfer your overdraft. If they do, make sure you check that the rates they charge aren’t higher.
- Pay off your overdraft before you switch. If you’ve got savings, you could use them to pay off your existing overdraft.
Otherwise, you may have to borrow money to clear the overdraft with your old bank before you switch accounts. If you do this, check the interest rate on the loan isn’t higher than the rate on your overdraft.
FAQs
Can the Bank Remove Your Overdraft?
Yes, the bank can remove your overdraft which is something to be aware of. Your overdraft is not guaranteed. The bank can either reduce your overdraft limit or remove your overdraft at any time. The reason they’d do this is if they think you’re overusing it or if you’re in financial difficulty.
If the bank takes away your overdraft for no reason, you have the right to complain about it. Especially if you get charged as a result of them removing it.
Can a Student Overdraft Affect Your Credit Score?
A student overdraft affects your credit score in the same way that a standard overdraft would. This means that if you manage your overdraft well it could improve your credit score. But if you use it all the time or go over your limit, it’ll hurt your credit score. Using the tips in this guide will help.
Does Applying for an Increase in Your Overdraft Affect Your Credit Rating?
The answer to this question depends on the bank. If they do a soft credit check it won’t affect your credit rating. But if they do a hard credit check it will. Check with your bank before you apply to increase your overdraft, so you know what kind of check they’ll do.
Disclaimer: We are not providing financial advice. These are just tips for informational purposes. Also, we are not affiliated to any of the external parties linked here, they are provided for reference only.