How does an overdraft affect your credit score?

An overdraft can help you get out of a tight spot if you need some short-term funds, but if you don’t manage it properly your credit score can take a hit. Find out how going into the red can impact your rating – and how to avoid the pitfalls.

An overdraft can help you get out of a tight spot if you need some short-term funds, but if you don’t manage it properly your credit score can take a hit. Find out how going into the red can impact your rating – and how to avoid the pitfalls.

Alex Hasty
Insurance and finance expert
minute read
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Posted 30 SEPTEMBER 2021

Why your credit score is important

Your credit score is used by lenders to decide whether you’re a high or low-risk borrower – in other words, whether you can be relied on to pay back any money you owe. It’s based on how you’ve managed money in the past.

With a good credit score, you’ll find it easier to get mortgages, personal loans and credit cards. You’re also more likely to have access to lower interest rates and be able to borrow more, as well as enjoy the perks of promotional offers depending on the provider you’re dealing with.

There are three main Credit Reference Agencies (CRAs) in the UK: Experian - the largest of the three, Equifax and TransUnion. These agencies keep a record of your financial data and your bank sends them information about your activity, usually on a monthly basis. This goes towards establishing your credit score.

Companies eligible to do so, like authorised lenders, can run searches through CRAs to get the details of your credit report.

Certain actions can impact your credit score, either positively or negatively – and this includes the way you manage your overdrafts.

Does having an overdraft affect your credit score?

Simply having an overdraft is unlikely to impact your credit score, but the way you manage it could do – both positively and negatively.

An overdraft is a way of borrowing through your current account and it’s either arranged (authorised) or unarranged (unauthorised).

An arranged overdraft is one that’s been agreed with your bank and it allows you to borrow extra money, up to a set limit.

For example, if your overdraft is £200 and you have £100 in your account but spend £150, you’re £50 overdrawn. This overspending is covered by your overdraft agreement.

Does using your overdraft affect your credit score?

Provided you pay back what you owe in line with your bank’s terms and conditions and don’t go over your agreed overdraft limit, there’s unlikely to be any negative impact on your credit score. In fact, if you stay within your limit and pay back your overdraft regularly, it might even boost your credit score as lenders can see you’re managing your money responsibly.

But if you exceed your agreed limit, or don’t have an authorised overdraft in place but still spend more than you have in your current account, it can have a negative impact on your credit score. It suggests to prospective lenders that you may not be in control of your spending.

Failing to pay off your overdraft, or being in the red (having a negative account balance) on a regular basis or for months at a time, can also impact your credit score for the same reason.

Does an overdraft appear on your credit history?

If you have an active overdraft, it shows up as a debt in the current account section of your credit report.

Lenders will be able to see:

  • What your overdraft limit is
  • How often you use it
  • How much you spend when you get overdrawn
  • How often you pay back what you owe

However, if you rarely use your overdraft and only for short periods when you do, your overdraft use might not show up in your credit history at all. This is because banks and building societies tend to send information to the CRAs just once a month.

Does paying off your overdraft improve your credit score?

As with all debts, it’s how you manage your overdraft that counts.

Paying off your overdraft responsibly can actually improve your credit rating by showing that you’re a reliable borrower. This involves:

  • Staying within your overdraft limit
  • Making regular payments to clear your overdraft – or spending less so your overdraft decreases
  • Using arranged rather than unarranged overdrafts

What happens if you can’t pay off your overdraft?

Late or missed payments will damage your credit score and can stay on your credit record for six years. This can make it more expensive to borrow money or get a mortgage when you need it.

This is reason enough to keep on top of your overdraft repayments. Our guide to paying off your overdraft can help.

If you think things are getting out of control, talk to your bank. They may be able to suggest a solution. Have a look at our guide to getting out of debt too.

Does this mean overdrafts aren’t a good idea?

Not necessarily. As a short-term loan, an arranged overdraft can be a life saver. If you’re faced with unexpected costs, like your car breaking down or a boiler packing up, you’ll be able to cover the extra spend with minimal stress, overdraft limit permitting. If your overdraft doesn’t cover it, you might be able to negotiate a temporary or permanent increase with your bank.

An overdraft also gives you the option to pay the money back over several months, if you can’t clear the debt completely when your next pay day comes around. However, be aware that interest rates on overdrafts are often very high - they start at around 20%, but you could be charged around 40% by some banks.

What are the alternatives to having an overdraft?

Firstly, overdrafts aren’t compulsory. You can opt out of having one.

Following a strict monthly budget is a way to steer clear of overdrafts and make sure you don’t spend beyond your means.

Certain credit cards and loans may also offer you a viable alternative to living in the red – and many come with lower interest rates than overdrafts.

If you have multiple existing debts, a debt consolidation loan might help you climb out of debt. You’ll be able to pay off the money you owe and replace multiple lenders with just one, to make repayments easier to manage.

But taking on a new debt is a big decision, as extending the length of the debt can mean paying more interest and could cost more in the long run. Plus, you may have to pay early repayment charges on your existing debt.

Whether you’re looking for a loan or a credit card, always read the small print and make sure you’re clear on the interest rate and terms of repayment before committing.

Compare the Market Limited acts as a credit broker, not a lender. To apply you must be a UK resident and aged 18 or over. Credit is subject to status and eligibility.

Frequently asked questions

Does simply applying for an overdraft affect your credit score?

When you apply for an overdraft, lenders will check your eligibility by looking at your credit score. Some banks will do this by what’s known as a ‘soft search’ or ‘soft credit check’. This shows up on your credit history as a ‘quotation search’ or ‘administration review’ and won’t impact your credit rating.

Other lenders will carry out a ‘hard search’, which will show up on your credit report and typically stay there for one year – although some, such as debt collection checks, stay longer. One-off hard searches won’t necessarily damage your credit score, but if you make multiple applications for credit in a short space of time, it could suggest you’re having problems managing your finances and this might affect your credit score.

Does increasing your overdraft affect your credit score?

If you ask your bank to increase your overdraft limit, they’ll do a soft search that won’t affect your credit rating - but they also have the option to do a hard search.

In itself, a hard search shouldn’t have a negative impact on your credit score, but if you make a lot of applications for credit in a short space of time, this can suggest you’re having problems with money. You then become a less appealing proposition to prospective lenders.

Does a student overdraft affect your credit score?

When it comes to protecting your credit score, a student overdraft requires the same responsible attitude as any other overdraft and you’ll still need to go through the relevant credit checks to be accepted.

However, a student bank account often comes with an interest-free overdraft, making it cheaper than the conventional option. But remember, you’ll still have to pay back whatever you borrow – usually after two or three years – and if you’ve had a high overdraft limit, this could be a considerable amount.

Overdraft limits may also vary depending on the term or year of study that you’ve reached.

If credit checks make you a good candidate, there may be the option to extend your overdraft during your studies. When you’ve finished studying, it might be possible to switch your student account to a graduate account. This gives you longer to pay off the overdraft.

The aim should be to pay off your overdraft before interest charges apply as these can be considerable and make it harder to get out of debt.

If you don’t pay off the overdraft regularly as required by the bank, you may find it much harder to get credit in the future, whether that’s for a credit card, loan or mortgage.

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