How does an overdraft affect your Credit Report?

Posted by Andrew Brown in Banking on 5 July 2019

An overdraft can either be a financial lifeline, or something of a millstone. Which side of that fence you fall probably depends on how much of that usage is pre-planned.

The effect that using an overdraft can have on your Credit Rating will also vary according to how you use it.

Let’s clear up the different types of overdraft, how best to manage one and what the wider impact on your Credit Report might be.

What is an overdraft?

An overdraft is a form of debt that allows you to access funds via your current account even when you have a zero balance.

There are two main categories of overdraft. The first is an authorised overdraft. Most UK banks offer this facility with certain accounts – either automatically or on request.

Overdraft facilities can also be added to an account after opening (sometimes for a small fee) and in many cases can be varied up or down - within a pre-approved limit - according to what you need at any given time.

Overdrafts are a useful and relatively cheap way of borrowing money in the short term. They are also very common in the UK, with over 26 million Brits using an overdraft at last count, and over 2 million of those using it every month. Students are particularly likely to use overdrafts and can benefit from 0% deals that don’t cost a penny in interest.

Be aware that as a credit facility, the majority of overdrafts will involve a credit check. The outcome of which will influence not only whether it is approved or not, but also what the limit will be.

Unauthorised Overdrafts

When an agreed overdraft limit is exceeded, this is known as an unauthorised overdraft. This will usually incur unpleasant additional charges – one of the most obvious (and expensive) differences between authorised and unauthorised overdrafts.

At the time of writing, if you were to enter an unauthorised overdraft in a typical NatWest or RBS account you could be charged £8 a day. With Barclays it’s £5 a day, at Lloyds it’s 1p a day for every £7 borrowed and at Santander it’s £1 a day.

There can often be additional Unpaid Transaction Fees too, which can quickly add up to a startling sum. In total, these spiralling fees cost UK consumers £2.4bn in 2017.

Improved Overdraft Regulation

Some good news for consumers is that new Financial Conduct Authority (FCA) regulations are due to come into effect on 6 April 2020 that will ensure fairer overdraft fees. It is expected to reduce the average unauthorised overdraft charge from £5 a day to less than 20p a day.

After the new FCA regulations take effect, banks will no longer be able to charge higher fees for unauthorised overdrafts than on authorised ones. The aim is to protect the most vulnerable customers from small amounts quickly escalating into hundreds of pounds.

All overdraft charges will now be based on an annual percentage rate (APR) rather than fixed daily or monthly fees, making it much easier for consumers to directly compare different overdraft accounts, and find the best deal for managing their finances.

Could an overdraft affect future credit applications?

There are a few main ways that an overdraft can affect your creditworthiness. Firstly, as a credit facility, most overdrafts are reported on your Credit Report as an account with a limit. This will be viewed as a potential debt by other lenders, even if you’re not using it.

Unlike other forms of credit like a personal loan or credit card, overdrafts are generally repayable on demand. In the eyes of a potential lender, an overdraft facility potentially increases the risk of you becoming overindebted.

The second way an overdraft facility could impact your ability to get credit in the future is through the way you manage it. If you are regularly ‘over’ your limit, it could be an indication that you struggle to manage credit, and could be enough to deter some lenders.

Finally, should a lender need to take action to remedy an improperly managed overdraft, it’s possible for late payment or even default markers to be added to your Credit Report, which could have a significant impact on your ability to get credit elsewhere in the future.

Where does an overdraft appear on my Credit Report?

The way that an overdraft is reported can vary, and it’s not uncommon for each of the UK’s Credit Reference Agencies to show different information, depending on its relationship with the bank in question.

When checking your Credit Report with checkmyfile, any overdraft that is being reported will appear in the ‘Borrowing History’ section. If you have an overdraft facility but don’t use it, it’ll be reported with a zero balance.

If you only dip into your overdraft on brief occasions, there’s a chance that the balance won’t be reported on your Credit Report. This is because lenders generally only pass information to Credit Reference Agencies once a month and so is likely to represent a ‘snapshot’ of usage, rather than real-time representation.

Benefits of using your overdraft

Using overdrafts properly offers useful benefits, utilising short-term credit for extra financial flexibility. This allows you to maintain payments on financial commitments, even if you don’t have the cash to hand at that moment in time.

Most lenders won’t have any issue seeing the presence of an overdraft on a Credit Report and will view it as a far better option than more expensive alternatives such as short-term loans. These are generally to be avoided wherever possible, as in addition to being extremely expensive, they will not be looked upon at all favourably by other lenders.

The effect of an overdraft on your Credit Score

Dipping into your overdraft now and again – basically using it as intended – shouldn’t have a significant impact on your Credit Rating.

In fact, showing that you can successfully manage and repay a short-term form of credit may even be a positive factor in the minds of future lenders.

If at all possible, it isn’t recommended to continually rely on your overdraft each month. Potential lenders could view this as a lack of ability to manage your monthly finances and spend within your means and assume that the same would apply in the future.

Similarly, if you ever decided to switch banks, having an overdraft could make the process more difficult. Your new bank would effectively be taking on risk from day one of a relationship and may not have the same appetite for risk as your existing provider.

Tips for managing your overdraft

Although using your overdraft appropriately will not directly affect your Credit Score, there are some tips to be aware of to help you stay on top of it.

  • Don’t think of an overdraft as a long-term form of borrowing. It’s great to have one in an emergency but try and limit your reliance on it.
  • Be aware of how close you are to entering or even exceeding your overdraft and draw up a clear budget every month.
  • Avoid incurring fees wherever possible – this only makes it more difficult to clear the debt.
  • Avoid using loans or other forms of borrowing to pay off your overdraft unless it is carefully considered and cheaper. This only shifts the debt and is not a long-term solution.
  • Communicate with your bank. It’s much better to communicate and try to find a solution than to bury your head in the sand.

Credit accounts, including overdrafts, will remain on your Credit Report for a period of six years, even after they are closed, and could affect your ability to get credit elsewhere.

Only checkmyfile lets you check and compare data from all four UK Credit Reference Agencies together in the same format.

If there is an overdraft being reported – existing or closed – that a lender would be able to see, you will be able to see the information for yourself and verify that everything is correct. It’s free for 30 days and then £14.99 a month. You can cancel at any time online, or via phone or email.

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