How an Overdraft Can Affect Your Credit Score

While an overdraft won't directly harm your credit score, letting it go unpaid can. This seemingly small misstep can trigger a chain reaction that ultimately leads to significant credit damage.

1. The Initial Overdraft: Your bank covers a transaction that exceeds your account balance. This action itself is not reported to credit bureaus and has no immediate impact on your credit score.
2. Accumulating Debt: If the negative balance and associated fees aren't paid back promptly, the bank will attempt to collect the funds. This is still between you and your bank.
3. Account Charge-Off: After a prolonged period of non-payment, the bank may close your account and write off the debt as a loss, an event known as a "charge-off."
4. Sent to Collections: The bank can then sell your debt to a third-party collection agency. This is the pivotal moment where your credit becomes directly threatened.
5. Credit Report Impact: The collection agency reports the unpaid debt to the major credit bureaus. A collections account on your credit report can cause a substantial drop in your score.

How Much Will an Overdraft Affect Your Credit Score?

While a simple overdraft won't directly appear on your credit report, its consequences can. Here are a few key things to consider regarding its potential impact on your credit score.

• Indirect Impact. An overdraft itself is not reported to credit bureaus and won't lower your score. However, if the negative balance and fees go unpaid, the situation can escalate and cause significant damage.
• Collection Accounts. If you fail to pay the overdraft, your bank may send the debt to a collection agency. This action is reported to credit bureaus and can severely harm your credit score for years.

How You Can Avoid an Overdraft Affecting Your Credit Score

Link to a Savings Account

Consider linking your checking account to a savings account for overdraft protection. If you overdraw, your bank can automatically transfer funds from your savings to cover the shortfall. This simple step can prevent your account from going into a negative balance and incurring associated fees.

Set Up Low-Balance Alerts

Most banks offer low-balance alerts via text or email. By setting a notification threshold, you'll be warned when your funds are running low. This proactive measure gives you a chance to deposit money and avoid accidentally overdrawing your account before any transactions are declined.

Choose the Right Card to An Overdraft

Improving your credit score is an achievable goal that can significantly impact your financial health, and consistent, positive behaviors can lead to meaningful changes. According to one expert guide, there are several proven methods to boost your score and maintain a healthy credit profile.

• Monitor your credit reports. Regularly obtain your free reports from the major bureaus to identify and dispute inaccuracies, detect potential identity theft, and track your progress.
• Establish automatic bill payments. Your payment history is the most significant factor in your score, so setting up automatic payments ensures you never miss a due date.
• Reduce your credit utilization ratio. Aim to keep your total balance below 30% of your available credit by paying down balances or requesting a credit limit increase.
• Become an authorized user. Being added to a credit card account with a long history of on-time payments and low utilization can help build your own credit file.
• Diversify your credit mix. Lenders like to see that you can responsibly manage different types of credit, such as credit cards (revolving credit) and auto or personal loans (installment loans).
• Limit hard inquiries. Space out your credit applications and use prequalification tools when possible to avoid multiple hard inquiries, which can temporarily lower your score.

The Bottom Line

An overdraft itself won't directly impact your credit score. However, failing to repay it can lead to a default, which will be recorded on your credit file and lower your score.

Frequently Asked Questions

Does having an overdraft appear on my credit report?

Yes, an overdraft is a form of credit and will be visible on your credit report. Lenders can see your overdraft limit and your history of using it.

Can going into an unarranged overdraft hurt my credit score?

It can. Using an unarranged overdraft suggests financial difficulty to lenders, which can negatively impact your credit score and make borrowing more difficult in the future.

Will closing an old overdraft account affect my credit score?

Closing a long-held and well-managed overdraft might slightly lower your score by reducing your total available credit and the average age of your credit accounts.