Can Overdrafts Affect Credit Score?

Does Overdraft Have Any Influence on Credit Score?

Borrowing more from your checking account means higher charges to pay and can be a costly affair. Not only do banks charge relatively expensive overdraft fees, but overdrawing your account frequently may impact your credit as well. Here is a guide on how overdrafts affect your credit score and some things you need to look at when facing such challenges.

What Is An Overdraft?

An overdraft is a condition whereby one spends more than he has in his checking account. Assume, for example, that you have $50 in your account and then write a check for $100, causing an overdraft of $50.

Banks used to outright reject such kinds of transactions earlier. Now, most banks will authorize the transaction and pay you the money as an automated overdraft "loan." The drawback is they will charge you an overdraft fee—typically between $30 and $35 for the courtesy.

For example, overdraft charges cause the $100 worth of things you purchased to put you back between $130 and $135. Should you repeatedly overspend your account numerous times before returning to the black, you risk costly recurrent overdraft fees.

Do Overdrafts Impact Credit Reports?

It is important to note that overdrafts themselves will not appear on your credit reports with Experian, Equifax, or TransUnion. This is the case because over-drafting a checking account is primarily considered as a bank product as opposed to a line of credit.

However, if a bank closes your checking account and sends it to collections because of unpaid overdraft fees, such a scenario may appear in your credit reports. Closing of bank accounts and reporting to collections are two credit-related events that hurt scores.

What’s more, they can negatively impact your credit scores: Overdrafts for days 7 and 8 entail credit scores of 550 for TransUnion and 525 for Equifax.

While occasional overdrafts here and there likely won't drag down your credit, a repeated pattern of over-drafting your checking account can potentially harm your scores in a couple of ways.

1. If the bank decides to close your account and sell it to collections, then that account will be reflected on your credit reports. Overdue bills are detrimental to credit since they reduce credit scores and remain on the credit report for up to 7 years.
2. While it’s true that you can still draw on your account, if you carry overdraft fees that are past due long enough, banks will report checking accounts in arrears to ChexSystems - a specialized consumer reporting agency utilized by many banks to aid in the decision-making process concerning account approval. If you have a ChexSystems record of mishandled accounts, other banks may reject your application for a checking account in the future.
3. A few large banks and credit unions also directly report checking account history to the major credit reporting agencies. Known as “banking credit,” this includes things like the length of credit relationship, type of accounts, and whether you have had overdrafts, returned payments, or closed accounts. Excessive negativity is also not good for credit score ratings.

Ways of Dealing with Overdrafts to Minimize Credit Risks

To keep overdrafts from causing issues for your finances and your credit, the key is addressing them promptly and responsibly.

• If you overdraw your account, make the balance above the $0 mark as soon as you can. Leaving the account in the negative for several weeks or even months may lead to its transfer to collections or its closure.
• Call your bank and find out if they are willing to freeze some of the overdraft fees. This is especially true if it’s your first time to overdraft; some banks will go ahead and waive one or more fees as a courtesy.
• Avoid using overdraft services at all so that purchases are rejected rather than processed if the money is not available. Just know this means the merchant may also charge a “returned payment” fee.
• Connect it to an overdraft line of credit or savings account overdraft transfer feature. This immediately directs money to pay for the purchase when you overdraw instead of racking up costly fees.
• Be in charge of your accounts by closely monitoring your balances, setting an alert, making a budget, and so on, to avoid spending beyond your capacity.

The Bottom Line

If an overdraft is only the occasional, brief occurrence that is promptly rectified, it should not be a tremendous source of credit risk, but repeated overdrafts can be problematic for credit scores and might make it challenging to obtain checking accounts in the future. Be cautious with your account, do not overdraw it, clear any balance as soon as you can, and talk to your bank about ways of reducing fees. It is, therefore, crucial to constantly check your checking account to maintain creditworthiness in the long run.

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