We’ve all dipped into our overdrafts, especially during challenging times or major events like Christmas and birthdays. However, the burning question remains: does using your overdraft impact your credit score?
When you use your overdraft, you are essentially borrowing money that isn’t technically yours, which is seen as a form of debt.
Types of overdrafts
There are two types of overdrafts: authorised overdrafts, pre-arranged with your bank, and unauthorised overdrafts, when you spend beyond your limit. Both types can influence your credit score, but the impact depends on how you manage them.
Simply having an overdraft that you occasionally use is unlikely to significantly affect your credit score. Generally, credit scores work in your favour if you use credit and then repay it. Dipping into around 30% of your overdraft and settling it is considered acceptable.
However, living consistently at the bottom of your overdraft, especially if you enter the unauthorised territory, can work against you. It’s also important to be aware of the interest rates on your overdraft, as they can be quite hefty.
How to get out of your overdraft
If you find yourself stuck in an overdraft cycle that seems challenging to break, consider applying for an interest-free credit card. Transfer your overdraft balance onto the card and assess the interest-free period.
For example if you’ve used £1000 of your overdraft, and the interest-free credit card term is 6 months, paying around £166.66 per month for half a year could clear the debt.
Given that overdraft interest rates can be as high as 39%, debt can quickly accumulate. If possible, open a new bank account without an overdraft facility to get rid of the temptation.
Applying for loans or mortgages
If you’re planning to apply for a mortgage, meticulous financial management is really important. Lenders scrutinise every detail, and a history of frequent overdraft borrowing may not work in your favour.
Lenders want assurance that you not only borrow money but also demonstrate responsible repayment. Avoid maxing out your credit limits, make payments regularly, and showcase a pattern of borrowing and repaying funds responsibly.
These practices are key to maintaining a healthy credit score, an essential aspect of your financial profile.
