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how does an overdraft affect your credit score?

how does an overdraft affect your credit score?

December 1, 2021
5 min read
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an overdraft facility can be a useful feature to have in case of financial needs. however, if you do not use it sensibly, this debt can negatively affect your credit score. read below to understand how it happens:

what is an overdraft?

an overdraft is an amount of money that you have withdrawn in excess of what you have in your account. since the money you have sent is more than what you have in your account, the bank treats it as a credit and you have to pay interest for the privilege. 

what is a credit score?

a credit score is a 3-digit number that ranges from 300 to 900 and represents the creditworthiness of an individual or business. the credit report and credit score is prepared by the credit bureaus operating in India such as - TransUnion CIBIL, Equifax, Experian and CRIF Highmark - by collecting payment history and debt details of an individual/business from banks and financial institutions. the lenders and credit card companies use the credit report and credit score to determine the risk involved in giving the credit to a borrower.   

how does an overdraft affect your credit score?

yes. credit reports include details of all the debts you own including overdrafts. the history of overdrafts and payments would help potential new lenders decide whether you are responsible when it comes to paying your debts on time. 

the banks and financial institutions send reports to the credit bureaus every month whether you have used your overdraft – and if so, how much you have borrowed and paid. so, if you have used an overdraft but paid it back at the end of the month, it may show up as a zero balance in your credit report. so, whether an overdraft will affect your credit score or not also depends on what your bank account looks like on that specific day. 

however, if you have missed payments or spent an unauthorized overdraft and the bank has levied charges over it, this will have a negative effect on your credit report.

here are a few ways an overdraft can affect your credit score:

history of missed payments – your credit score will drop if you have a habit of missing your overdraft payments at the end of the month, or if you only repay the minimum amount due.

high credit utilization – the credit bureaus will drop your credit ratings if you have a habit of maxing out your overdraft as it shows high credit utilization. keeping your credit utilization ratio low to improve your credit score.

high interest – if you use unarranged overdrafts, you may have to pay high interest to banks which could result in a cycle of debt. too much unpaid credit means you are at a high risk of being a defaulter. 

what's the difference between authorized and unauthorized overdrafts?

an authorized overdraft is a facility where the banks allow you to spend more money than you have by paying interest over the overdraft amount. in this case, there's a pre-agreed overdraft limit. an unauthorized overdraft means you have borrowed more money than the pre-set overdraft limit. an unauthorized overdraft may be more damaging to your credit score than an arranged one.

does applying for an overdraft affect credit score?

when you apply for an account that offers an overdraft facility, the bank or the financial institution will want to look closely at your credit history and do a 'hard inquiry' to see if you have been a responsible borrower. every time a hard inquiry occurs, it is noted down on your credit report and can hurt your credit score. too many hard inquiries in a short span of time will be viewed as a sign that you have financial difficulties and may not be able to pay back your debts on time. 

does increasing an overdraft affect your credit rating?

if you apply for a bigger overdraft, the bank or the financial institution would want to carry out another hard inquiry of your credit report. with every hard inquiry, your credit score will keep dropping a few points. also, if you use more of your overdraft, it will further push your total debts and therefore could hurt your credit score more. however, if you have a higher financial requirement, it's better to apply for a larger overdraft with your bank, rather than crossing over your allowed overdraft limit every time. 

does reducing an overdraft affect your credit rating?

as a general thumb rule, the lower you borrow, the better it is. in fact, banks and financial institutions also prefer someone who borrows less, rather than more. so reducing your overdraft may help you in improving your credit score.

does paying off an overdraft will improve your credit rating?

by paying off your overdraft, you can reduce your overall debts, and hence this could be a booster for your credit score. lenders would also like to see that even if you have an authorized overdraft, you have used it sensibly. lenders would see you as a responsible borrower who pays debts on time and hence would be willing to let you borrow. 

how to check a credit score?

want to find out your credit report and credit score? now, you can easily get your credit score for free through the CRED website and CRED app. click on the link provided below to check and download your credit report today.

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