Sam Bromley
Do you see your overdraft as your own money? According to research from the Financial Conduct Authority (FCA), many of us who use an overdraft often view it as an extension of our own money instead of borrowing.
However, while an overdraft may seem to be safer and lower-risk than other credit products, you’re still getting into debt when using one. And just like other types of credit, such as loans and credit cards, using an overdraft can affect your credit score.
Does an overdraft affect your credit score?
Overdrafts are intended for short-term borrowing. For example, when faced with an unexpected expense, your overdraft can act as a safety buffer, letting you borrow from your bank until more money gets added to your account.
There are two types of overdrafts – arranged and unarranged.
- An arranged overdraft is an overdraft that’s authorised by the bank. You can borrow money up to the agreed overdraft limit. You will usually need to apply for an arranged overdraft. You will usually need to apply if you want to increase your overdraft limit, too.
- If you go beyond this overdraft limit without your bank’s authorisation, you’ll fall into an unarranged overdraft – the bank could also decline payments over the limit.
Overdrafts show up as a debt on your credit report and lenders will be able to see your overdraft limit and balance.
If you stay within the arranged overdraft limit and pay off your overdraft regularly, your credit score shouldn’t be harmed. However, your credit score may be affected if you go into an unarranged overdraft regularly or if you take a long time to clear the debt. This can signal to lenders that you’re struggling to manage your finances.
How an arranged overdraft affects your credit score
When managed sensibly, an arranged overdraft shouldn’t affect your credit history negatively – and having an overdraft could help you build a good credit score.
For example, if you have a limited credit history, opening a bank account is one of the first steps you can take to start building one. Keeping the same account open for multiple years can also help to improve your score.
Lenders will be able to see an overdraft and whether you’re using it because only the credit aspects of your account show on your credit report. But if you’re not using your overdraft, your account’s balance on your credit report will be zero. Your credit report doesn’t show the money you have in your account as a positive balance.
Using an overdraft and clearing it in good time can improve your credit score because it helps to show lenders that you’re on top of managing your finances.
Banks usually report data to credit reference agencies once a month, so temporary overdraft use may not even appear on your report, provided you’ve cleared it by the time the bank reports its data.
Be aware that banks may be less likely to offer you an overdraft if you have a poor credit score in the first place. When you use your overdraft, you’re getting into debt – so it should only be used if you need emergency money and can pay it back quickly.
If you’re looking to build your credit history, products such as credit builder credit cards or 0% credit cards may be more suitable for your situation. They are often a cheaper and more reliable way to borrow and allow you to make regular repayments, which are then reported to the credit reference agencies.
How an unarranged overdraft affects your credit score
Using an unarranged overdraft can hurt your credit score.
If you go over an arranged overdraft limit or stay in an unarranged overdraft for a long period of time, your bank may report it to the credit reference agencies. The debt could show as arrears on your credit report, potentially causing your credit score to go down.
If lenders see that you use an unarranged overdraft regularly, it could be a signal that you’re struggling to manage your finances.
It’s also important to consider the impact of unarranged overdrafts on your other repayments. For example, if there isn’t enough money in your account to pay a credit card bill, your bank may not let the payment go through. If you can’t then pay your credit card bill, it can hurt your credit score.
» MORE: How can I check my credit score?
Does increasing an overdraft affect your credit score?
Simply increasing the limit on your arranged overdraft shouldn’t impact your credit score negatively.
Lenders will be able to see the increased limit on your report. But if you stick within this agreed limit and regularly clear your overdraft, your credit score shouldn’t be affected.
When you apply for an overdraft – or apply to increase it – your bank may run a credit check. Each bank has a different application process, but be aware any hard credit searches will show on your credit report. Too many hard searches in a short space of time can damage your credit score because it can look like you’re having money problems.
If you regularly spend up to and over your limit and struggle to clear your overdraft, lenders will likely view this negatively. Keep this in mind if you’re thinking about increasing your overdraft. Do you have any alternative options, such as applying for a credit card, a personal loan or using your savings?
These alternatives may be cheaper than an overdraft, which often has higher interest rates. Overdrafts are intended to be used as a short-term safety net, not for long-term borrowing.
» MORE: What is a credit score?
Protecting your credit score when using an overdraft
If you use an arranged overdraft as intended – an emergency option for short-term borrowing in small amounts – it’s unlikely that your credit score will be affected. Clearing it as quickly as possible will ensure that a large debt doesn’t build up.
Financial problems can arise if you rely on your overdraft for essential outgoings and don’t keep an eye on your overdraft use.
To help you protect your credit score (and your finances in general) when using an overdraft, keep these tips in mind:
- Check your account balance regularly. It’s important to know when you’re approaching your overdraft limit because this can help you budget, avoiding going into an unarranged overdraft and your bank refusing payments.
- Read all correspondence from your bank. Overdrafts can be an unreliable way to borrow because banks can change your overdraft limit and interest rate. Make sure you’re opening letters and emails from your provider so you don’t get caught out.
- Clear your overdraft often. Banks usually report data to credit reference agencies once a month. Using your overdraft occasionally and clearing it regularly may mean your overdraft use doesn’t even appear on your credit report.
- Explore alternatives. If you need to borrow a larger sum of money or over a longer term, consider a credit card or personal loan. These alternatives can be more reliable ways to borrow because banks can remove or reduce your overdraft – they are often cheaper too. These products can also be more reliable ways to build a credit history.
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