How Does My Overdraft Affect My Credit Score?
Do you want to apply for car finance but are worried that your overdraft will affect your credit score? As you know, lenders check credit scores when they assess loan applications. But does an overdraft affect credit score? If you have an overdraft, and it pulls down your credit score, then it’s possible that you may not be able to get the car finance rate that you’re hoping the lender will offer. In worse cases, the car finance company might reject your application altogether. Let’s learn more about what an overdraft is and what you can do about it.
What is an Overdraft?
To answer the question, ‘Does going into overdraft affect your credit score?’ let’s first understand what it means when you have an overdraft. The term overdraft refers to a kind of debt that is connected to your bank account. If the figures on your bank account go negative, it means that you have spent more than the amount that was available in the account. This is when an overdraft happens, and you now owe money to the bank.
How Overdrafts Work
Did you know that overdrafts can sometimes be arranged and used to manage money? Overdrafts can help in some situations if used correctly. For example, in an arranged overdraft, your bank has given you the go signal to use an overdraft. You have their permission and the bank is already expecting your account to be overdrawn. However, if it is an un-arranged overdraft, then you would have to pay back the bank the amount you owe plus interest that could be as high as 40%.
How Much are Overdraft Interests?
The actual amount you are charged will of course vary depending who you bank with. Overdrafts are similar to other loans because the bank will be charging you interest for lending you a certain amount of money. The interest you’ll pay will be charged as a percentage of the amount you borrowed from the bank. To know the exact rate, find out what your account’s Annual Percentage Rate is. It’s better to check the APR rather than the EAR or Effective Annual Rate because the APR includes other fees and charges. The EAR will only tell you the interest rate and some banks charge other fees to set up the facility. The way the rates work is the higher the rate, then the more interest you’ll pay for the amount the bank lent you. Most banks these days have online calculators so you can access details of rates etc.
Does Overdraft Affect Your Credit Score?
The short answer to the question of whether an overdraft affects credit score is yes, it will. However, it’s not as bad as you think it might be, especially if it’s the first time or the arranged overdrafts are infrequent. Also, if you’ve paid the bank or you’re diligently making the payments in the agreed schedule, then overdrafts could potentially boost your credit score since you’re demonstrating your ability to handle this kind of debt.
On the other hand, if you’re constantly in overdraft, then that’s when you can expect your credit score to suffer. If you don’t settle your debts with financial institutions, in this case, a bank, then you could lose a good number of points on your credit score. A low credit score can affect your ability to get loans and other financial products in the future. Some lenders might accept your loan applications but at a higher interest rate. Others could reject your loan applications altogether because they’ll assume you can’t handle your finances responsibly.
When Do Overdrafts Become Problematic?
An overdraft is not something to stress yourself over, as long as it was an arranged one and you’ve been paying back the bank on time every time. If it becomes your habit to depend on your overdraft, then you’ll always be struggling to pay back the amount you owe plus the huge interest. This can be very stressful because you’ll always be thinking about how to settle large debts that seem to be never-ending. It’s important not to get caught up in a vicious cycle of going into overdraft and then paying and repeating it.
Actually, it would be wise to pay off what you owe the bank first before applying for other financial products like car finance. Imagine if you have to pay back that debt and then you also have to pay for a car. That could bring too much stress on you and could affect your performance at work, your sleep, or your health. Clear off your debt from an overdraft first, allow your credit score to bounce back, and then you can try applying for car finance. This will give you a better chance of getting a good rate of interest on future borrowing.
Paying Back an Overdraft
If you’re in overdraft and want to pay back what you owe the bank, you can use your emergency funds for that. In case you have enough money saved to pay back everything at once, then that would be the best way to do it. Remember that the bank could charge you 40% on your overdraft, so to prevent racking up interest, you could just use your savings and get it settled once and for all. Having an overdraft is not the best way to borrow money.
Another thing to note about repaying an overdraft is that they don’t usually come with a ret repayment plan or schedule. You would be the one to decide how much you’ll pay and how often if you were to pay in instalments. If the overdrawn amount is substantial and you don’t have enough in your emergency funds to pay off everything at once, then you can pay in instalments. Just make sure that you stick to the schedule you’ve prepared for yourself so you can finish paying it off as soon as possible.
Hopefully, this article was able to clear up whether an overdraft affects your credit score. You can use an arranged overdraft for whatever purpose you like. As long as you will be able to pay back what you owe in a timely manner, then there’s nothing to seriously be worried about. However, if you’re into a cycle of going into overdraft and are now trapped in repaying that debt, focus on getting that settled first before applying for other types of financial products. Citizen's Advice is a good starting point for help if find yourself in financial difficulty, and do contact any lender urgently to discuss a solution, you can expect them to be supportive and they will look at working out a plan you can afford. 👍