Vanguard Money Digest

January 31, 2020

Utilizing overdraft to avoid a bad credit score

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By Elizabeth Adegbesan

An overdraft is a short term credit facility that allows you withdraw money above the actual amount in your account. The excess is subject to a specific limit and interest rate is charged on it as a bank loan.

Overdraft is an open credit which can be used repeatedly until the balance on the account reaches a certain prearranged limit with a specific repayment date, usually one year.

Though the bank charges overdraft fee for the transactions that exceed your bank balance, you might even have to pay a fee for each day your account remains negative.

Having a good credit score is a major criterion for accessing credit in a bank. Hence, what do overdrafts mean for your credit score?

Overdrafts and credit score

Bank overdrafts will not affect your credit score if you pay off within the specified time. Once you do this, you can continue using your current account.

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However, if you neglect to fund the negative account balance arising from an overdraft, the bank may report your account to the credit bureau and it will be added to your credit report. The negative report that stems from your overdraft will affect your credit score. A debt collection account will remain on your credit report, even after you’ve paid it, unless you negotiate with the debt collection agency to remove it.

If you are routinely in “unauthorised” overdraft territory, this is taken as a sign that you are struggling with your finances and might have difficulty repaying credit. This could reduce the amount your bank (lender) is willing to extend on credit cards, personal loans or other types of finance.

More importantly, it will make your bank give you high interest rate on your overdraft or any other loan facility you may seek.

If you are completely unable to repay your overdraft, it’s possible that you will be referred to a debt collection agency, which would affect your score. In addition, the involvement of a collection agency will increase the overall cost of the overdraft.

If you regularly use your overdraft and repay it timely, this shows you are managing credit responsibly, and this will count positively to your credit score. This will also mean lowering your cost of overdraft or any other bank credit.

Tips on best overdraft practices

The following practices will help your credit score if you must use overdraft:

  • Pay off your overdraft monthly, or timely;
  • Prepare a budget to minimize how much you use the overdraft. Rely on it for essential spending;
  • Check your credit score regularly; and
  • Know your authorised overdraft limit to avoid excessive charges or interest rates on unauthorised overdraft.