Do Overdrafts Affect Your Credit Score? Here’s What to Know
Yes, an overdraft can affect your credit score, but its impact depends on factors like the type of overdraft account you use, whether you pay your overdraft promptly, and whether you exceed your overdraft limit. Ultimately, an overdraft can damage or benefit your credit score depending on how you use it.
Here, we’ll explore what you can do to ensure that your overdraft usage is as beneficial for your credit score as it can be. If you’re ready to keep your credit score in good condition and ultimately save money, keep reading to learn more!
Looking for information on student overdrafts? Check out our separate guide!
What is an Overdraft?
An overdraft is a type of credit that allows you to spend more than you actively have in your current account. For example, if you spend £50 and you only have £25 in your account, you’d use £25 of your overdraft and owe that money back to your bank.
There are two main kinds of overdrafts. Each has a different impact on your credit score, so let’s take a closer look at both.
1. Arranged or Authorised Overdrafts
An arranged or authorised overdraft is an overdraft that you have been approved to use by your bank. The terms of your arranged overdraft will establish how much you can overdraw your account by, the interest rate, and repayment requirements.
Keep in mind that arranged overdrafts typically have interest rates on the higher side, often ranging from 20-40%. Some banks might charge even higher interest rates, so pay attention to this detail.
2. Unarranged or Unauthorised Overdrafts
Unarranged or unauthorised overdrafts are essentially the opposite of an authorised overdraft. If you have an unarranged overdraft, you’ve spent more money than you have in your current account and haven’t established an agreement with your bank allowing you to do so.
Note: If you overdraw an arranged overdraft beyond your limit, that’s also considered an unarranged or unauthorised overdraft.
Related read: What happens if I can’t pay my overdraft in the UK?
How Do Overdrafts Affect Your Credit Score?
An overdraft’s impact on your credit score depends on two main factors: the type of overdraft you use, and how you use that overdraft.
The Type of Overdraft
When it comes to your credit score, arranged overdrafts are always better than unarranged overdrafts. Remember, an overdraft is like a tiny loan that your bank allows you to take out on the fly. Using an unarranged overdraft is a quick way to illustrate that you’re struggling to manage your finances, and that can damage your credit score.
When you have an arranged overdraft, using it alone is less impactful. Instead, it becomes more about how you use your arranged overdraft.
How You Use Your Overdraft
The best way to use an arranged overdraft is to treat it like a credit card. This means:
- Using it sparingly
- Paying it off promptly and in full
- Using a small percentage of your available overdraft limit
Again, your overdraft is a form of credit. Using it conservatively and paying it off in a timely manner demonstrates your ability to make repayments and manage your finances, which can benefit your credit score. However, if you don’t maintain your overdraft account, you can accrue interest and fall deeper into debt, which will ultimately damage your credit score.
Does Your Overdraft Show Up on Your Credit Report?
Whether your overdraft shows up in your credit report depends on the factors we explored above: the type of overdraft you use and how you use it.
If you use an unarranged overdraft, it will show up in your credit report. This is a negative mark that can make it harder to secure other types of credit in the future.
Comparatively, your arranged overdraft’s balance will show in your credit report, but that’s not necessarily bad for your credit. If you don’t use your overdraft, it won’t show any balance and it won’t impact your credit. If you do use your arranged overdraft, your credit report will display the amount you currently owe. Not paying off your overdraft can also leave a negative mark in your credit report.
Finally, if you use your overdraft and pay it off, your credit report may simply show a balance of zero even though you’ve used it. This is because most banks only report to credit reference agencies once a month, so you may have cleared your overdraft between their reports.
Use Your Overdraft Wisely
Overdrafts can be a convenient form of credit. They allow you to access the funds you need, when you need them, without going through payday lenders or other risky alternatives.
As you continue looking into overdraft accounts, remember that:
- Overdrafts are a form of credit
- Always use an arranged overdraft and never overdraw your account if you don’t have an arranged overdraft set up
- Treat your overdraft like a credit card—pay it off on time and in full
If you’re on the credit-building journey, understanding how overdrafts work is essential for keeping your credit score in good shape. The Pave app can help. By keeping track of your account balances and upcoming bills, the Pave app can empower you to make smarter budget decisions and minimise the need to use an overdraft. Plus, the Pave app can give you personalised credit building tips, and may even be able to extend you a line of credit so you can avoid using an overdraft altogether.
Ready to take your credit score to the next level? Download the Pave app today!