Does an overdraft affect my credit score?

What is an overdraft?

An overdraft lets you borrow money through your current account rather than taking out loans or a credit card. Using your overdraft means your current account balance is below zero and you owe the bank money.

Your bank will charge you interest for using your overdraft. How much interest you pay will depend on how long you are overdrawn. If you have an overdraft facility but don’t use it, then you will not be charged for it.

An overdraft doesn’t usually have a set repayment schedule – you can repay amounts whenever you want. However, your bank can ask you to repay your overdraft in full at any time.

Authorised overdrafts

An arranged or authorised overdraft means you have a pre-agreed overdraft limit. Your bank lets you borrow up to this limit when there's no money left in your current account.

Unauthorised overdrafts

An unarranged or unauthorised overdraft is where you haven't agreed an overdraft with your bank, but you have spent more money than the amount in your current account.

Do banks charge overdraft fees?

In April 2020 the Financial Conduct Authority (FCA) banned overdraft fees on top of interest.

Bank must now charge a single annual percentage rate (APR) on overdrafts. This makes it easier to compare accounts. Most UK banks charge about 40% interest on overdrafts.

Do overdrafts appear on your credit report?

Overdrafts will usually appear in the debt section of your credit report. This is because banks report details of overdrafts to credit reference agencies Experian, Equifax and TransUnion.

However, if you’ve paid off your overdraft before the bank sends its monthly report, there may not be any record on your credit report.

Lenders will be able to see the following overdraft credit history on your credit report:

• your overdraft limit
• your credit utilisation (how much of your overdraft you use, how often and how fast you repay it)
• how much you are overdrawn (at the point in time the information is sent to the credit reference agency)

Factors that can affect your credit rating

Several factors can affect your credit rating when using an overdraft.

Increasing overdraft limits

If you apply to increase your overdraft limit, your bank will look at your credit record and payment history to determine your reliability as a borrower.

In many cases, this will be completed through a soft credit check and won’t affect your credit rating. But some banks might use a hard credit check that will be visible on your credit report.

Too many hard searches in a short space of time could tell lenders that you are struggling to manage your finances, and may be relying more on credit. This can lower your creditworthiness, which can cause your credit score to dip.

Decreasing overdraft limits

Either you or your bank can decrease your overdraft limit. But spending more than your new, lower limit will have a negative impact on your credit score.

Even staying within the new limit could affect your credit rating. Your credit utilisation ratio shows how much of your available credit you are using. Using more than 25% of your total credit shows you rely on it too much. The larger the number, the worse the impact on your credit score.

If your overdraft limit were £1,000 and you used £500 of this, your credit utilisation ratio would be 50%. But if you lowered your overdraft limit to £600 and still used £500 of your overdraft, your credit utilisation ratio would be 83%.

This means it may be better to not reduce your overdraft limit.

Paying off your overdraft

Paying off your overdraft could boost your credit rating. Paying your overdraft shows lenders that you are borrow responsibly and can manage your debt.

Clearing debt will also lower your credit utilisation ratio, which can help your credit score.

How much will being overdrawn affect my credit rating?

Being overdrawn is a way of borrowing money, so it will have an impact on your credit rating and creditworthiness.

• If you have an overdraft facility but you are not using it, your credit report will show your balance as zero.
• Being slightly overdrawn for short periods of time is unlikely to have a big effect on your credit rating.
• But being constantly overdrawn or borrowing up to (or beyond) your overdraft limit could have a big negative effect on your credit score.

Can an overdraft improve your credit score?

Having an overdraft can improve your credit score. If you’ve never borrowed before, you’re unlikely to have much credit history. Using an overdraft well could be a great credit-building tool and help you get accepted for credit in the future.

Tips include:

• Stay well within your overdraft limit
• Pay your overdraft off promptly
• Don’t get overdrawn often.

Can an overdraft affect a loan application?

An overdraft can affect a loan application as any existing borrowing you have will be factored into the decision about whether to lend you money.

You may be able to get a loan if you have an overdraft, but you’ll stand a better chance if your overdraft balance is zero. Lenders may be concerned that you already rely too heavily on credit and might struggle to repay a new loan.

On the other hand, if you only dip into your overdraft from time to time, don’t exceed the limit and always repay what you owe, this can show lenders that you’re a responsible borrower. This could increase your chances of being accepted for a loan.

Could an overdraft affect my mortgage application?

An overdraft could affect your mortgage application as regular overdraft use suggests to lenders that you are struggling to manage your finances.

Mortgage brokers generally advise against applying for, or extending, an overdraft if you are looking to apply for a mortgage in the next six months.

What happens if I never pay my overdraft?

If you can’t pay your overdraft, interest charges can rack up fast. This will increase the amount you owe. Your bank may withdraw your arranged overdraft and ask for full repayment. This could affect your credit score.

You should tell your bank why you can’t meet your repayments. It might offer you a repayment plan or reduce the interest rate on the amount you owe.

In some cases, your bank might send you a default notice telling you to pay up or your account will be closed. If you ignore this warning or you don’t agree to a repayment plan, you could be taken to court.

If you’re struggling with your finances, it’s worth speaking to a debt charity for fee-free advice.

Tips to manage your overdraft responsibly

According to figures from YouGov, the UK is overdrawn by £3.5bn, so if you use an overdraft, you’re not alone. These tips can help you manage your overdraft and pay it off more quickly:

1. Create a budget: Having a budget can help you pay off the amount you’ve borrowed. Ideally, you should aim to repay your overdraft after you’ve been paid each month.
2. Use your savings: If you have an overdraft racking up a high rate of interest, it could be worth using any savings to clear it. The interest rate on your savings is likely to be lower than the interest rate you’re being charged on your overdraft.
3. Move to an interest-free overdraft: If you’re struggling to pay off your overdraft, see whether you can switch current accounts to take advantage of a 0% overdraft for a few months. Many providers will let you switch current accounts with an overdraft, although they will look at your credit score. You can then focus on paying off your overdraft without paying interest.
4. Use a 0% money transfer credit card: If you have a good credit history, you could apply for a 0% money transfer credit card. These let you move money from your credit card into your bank account. You can use the funds to pay off your overdraft. You then make monthly interest-free payments to your credit card provider. Keep in mind there will usually be a transfer fee to pay – often around 4% of the amount you’re transferring.
5. Take debt advice: If you find it hard to repay your overdraft and you have other debts too see a debt adviser. They might suggest a debt consolidation loan. This involves borrowing enough money to pay off all your debts and then pay a monthly sum to just one lender (usually at a cheaper interest rate).

Summary: Overdrafts and credit scores

If you use your overdraft carefully, by not borrowing more than your limit and making regular repayments, your credit score could go up. But if your overdraft use suggests you are in financial difficulties, such as always being overdrawn or exceeding your limit, it could result in your credit score going down.