Does an Overdraft Affect Your Credit Score?

Written By Cathy Lovering
Last updated June 18, 2021

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Credit
June 18, 2021

Simple. Thrifty. Living.

An overdraft can help you manage your financial obligations. In a pinch, an overdraft means a payment goes through even if you don’t have enough money in your bank account. But what does an overdraft mean for your credit score? Although an overdraft is essentially your bank loaning you money—you do have to pay the money back to them—it rarely affects your credit rating.

Having an overdraft can’t help your credit rating. It doesn’t count towards the calculation of how much credit you have available and how much you used. There are two instances when an overdraft can lower your score, however: when you apply for overdraft protection and if you don’t pay back your overdraft and the debt goes to a collections agency.

An overdraft allows you to overspend a bank account. When you don’t have enough funds to cover a transaction, the bank still approves it. The result is your bank shows a negative balance. You have to pay back this negative balance, which typically happens the next time you make a deposit big enough to cover what you owe.

Overdraft comes with fees. You may have a pay-per-use fee every time your account goes into overdraft or that overdraft becomes bigger. The bank may also charge a monthly fee just for having the overdraft protection option, or it may be a feature of a more expensive banking package.

There are two types of overdraft. The first is when your bank allows a transaction that exceeds the amount of money available in your account, on a discretionary or one-off basis. The second is when you have overdraft protection attached to your bank account. You typically have to apply for this kind of protection by filling out a credit application.

Your bank may also have the option for you to link two accounts, so if one has insufficient funds, the other covers the payment. This is a preferred option for people who choose not to have a negative balance and who have available funds in other accounts at the same bank. Banks may still charge a fee for this service, however, and you have to keep tabs on your accounts to make sure you have enough money in both.

Even if you have overdraft protection, it won’t show up on your credit report. Since banks do not report checking account information to credit agencies, overdraft protection is not included in your score. That’s despite the fact that having overdraft protection functions as a temporary form of credit to protect against bounced payments.

Even if your bank approves you for overdraft protection, it won’t raise your credit score like having a line of credit or credit card might. In that respect, it’s not like a short-term loan and does not contribute to the credit mix that banks like to see when they look at credit reports.

Although banks don’t report overdrafts, there are nonetheless ways an overdraft can lower your credit score. These are before you get the overdraft and if you fail to pay back what you owe.

When you apply for overdraft protection, it can trigger a hard inquiry. With each application for new credit, your lender looks at your credit report. This is called a “hard inquiry,” which temporarily makes your credit score drop. If you apply for overdraft protection, your bank will typically run your credit. So before you even have an overdraft—before you even use it—this safety net makes your score go down a little bit.

When you don’t pay what you owe, the bank sends the file to collections. Since an overdraft works like a temporary loan, the bank expects the money returned. The bank account terms and conditions should outline how much time you have to pay back your overdraft. If you don’t pay it back in time, the bank can take steps to recover the funds. They may send the file to collections. A collections account does show up on your credit report.

Having a collections account causes a big hit to your credit score. These accounts stay on your credit report for seven years. That time starts from when the original debt first became past due.

There is a database that does track bank account use: ChexSystems. It is how banks share information about customers who have misused banking products, by bouncing checks or not paying overdraft fees. Even if your bank account information does not show up on your credit report, it is possible a misstep could cause the creation of a ChexSystems file.

If you do have a ChexSystems file, it might make it hard to open a new bank account. However, there are options, such as second-chance bank accounts. These may come with higher conditions, like keeping a certain amount of funds in the account at all times. If these are not an option for you, you can take steps to live without a bank account. ChexSystems files last for five years, after which the negative report no longer shows up.

Since an overdraft does not typically affect a credit score, whether you should apply for overdraft protection comes down to personal choice. On the one hand, you don’t risk declined payments and the insufficient funds (NSF) fees that come with them. At the same time, overdraft protection also comes at a cost.

As you review your banking choices, ask yourself all the important questions. You can start with, does an overdraft affect my credit score, but also go on to contemplate how much banks charge in fees for these services. Responsible use of banking often means finding a balance between convenience and prudent spending.

About the Author

Cathy Lovering

Catherine Lovering has written about personal finance and health for over 10 years, with bylines on IvyExec.com and Healthline.com. She holds an LL.B. (J.D.) from the University of Victoria.

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