Overdrafts can be a real drag. Nobody enjoys the sight of a negative balance on their checking account. But, beyond the subtle embarrassment, do they also mess with your credit score?
The answer, like most things in finance, is a bit nuanced. Overdrawn accounts don’t generally affect your credit score. But, your credit score may take a big hit if you don’t pay back what you owe.
So, do overdrafts affect credit score? This article will explain how overdrafts affect your credit score and how you can manage them responsibly.
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What causes an overdrawn account?
An overdrawn account is one that’s dipped into the negative because you’ve spent more than you have. It can happen when you write a check, buy something with a debit card, have money taken out through automatic bill payments, take too much out from the ATM, or make a withdrawal either electronically or in person.
Rather than display the dreaded ‘Insufficient Funds’ message, most banks and credit unions can cover the shortfall if you opt into overdraft protection.
The problem is that you owe the bank not only the money spent but also a fee from the overdraft.
How do overdraft fees affect credit?
In general, overdrafts will not affect your credit score, because they’re associated with your debit account rather than your credit.
However, if you fail to pay back your debts, the bank may turn to a collections agency, which will impact your credit score.
What does affect my credit?
Since there’s no reason to fret over overdraft fees (as long as you pay them back in a reasonable time), it’s probably a good idea to review the things that can affect your credit score.
These are other factors that can affect your credit:
- Payment history: This may be the single most impactful factor on your credit score. A history of on-time payments boosts your score. On the flip side, late or missed payments and accounts in collections can seriously hurt it.
- Hard inquiries: Every time you apply for a new line of credit (e.g. a loan), the lender does a hard inquiry on your credit report. This inquiry temporarily lowers your credit, but the impact on your credit score will typically not last more than a year. If too many lenders conduct hard inquiries on your report within a short space of time, it can raise red flags and signal that you are overextending yourself financially.
- Credit mix: A diverse, healthy blend of credit accounts including loans (mortgages, car loans) and revolving credit (credit cards) can positively impact your credit score. It indicates that you can manage different credit types responsibly.
- Credit utilization: This is the percentage of your available credit limit that you’re currently using. Creditors prefer you keep your credit utilization at 30% or below. It tells them that you don’t excessively rely on credit, which is good for your credit score. On the other hand, if creditors see that you have a habit of maxing out your credit cards, they’ll associate more risk with your finances, which isn’t good news for your credit score.
- Negative information: Negative info on your report like bankruptcies and foreclosures can seriously pull down your credit score — and do so for several years.
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How to prevent overdrafts
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Yes, overdrafts don’t usually affect your credit score. But that doesn’t make overdrawing a good habit. The tables can quickly turn if you rely on your bank to pay for expenses you can’t technically afford.
Use these strategies to keep overdrafts at arm’s length.
Make a budget and stick to it
One of the most effective ways to avoid an overdrawn account is to manage your finances and create a budget. Start by identifying your short-term and long-term financial goals, like saving up for a vacation or a house.
Next, take a hard look at your monthly expenses. If you’re spending more than you’re bringing in, consider ways to make a bit extra on the side. Committing to your budget will take hard work, but it’ll be worth it.
Check your bank accounts daily
Checking on your accounts daily keeps you posted so you know how close you are to having an overdrawn account. Plus, it helps you catch billing mistakes. You might find you’re being charged for a subscription service you thought you had canceled, or that your check didn’t process the day you expected.
Remember that deposits are not immediately available for use, so you can overdraw your account even if you just made a deposit.
Checking your bank account to see when your deposit has been fully processed will help you avoid overdrawing.
Automate your bills
Automating your bills will not only ensure you never miss a payment, but it will also help you keep track of the amount of money you have available to spend at any given time.
This will make it easier for you to avoid overdrafts and late fees.
Modern technology allows you to automate everything from driving to cable bill payments. Contact your providers to ask about automating your payments. Some may even offer a discount for doing so!
Connect a savings account to your checking account
Linking a savings account to your checking account is like a personal overdraft protection measure.
It allows your bank to automatically transfer funds from your savings to cover a debit card purchase or ATM withdrawal that would otherwise overdraw your checking account.
Register for low-balance alerts
Many banks offer low-balance alerts that notify you by text message or email when your checking account dips below a specific threshold. These alerts give you a heads-up to take action before an overdraft occurs.
You can adjust the amount that triggers an alert to suit your comfort level and spending habits.
The best policy is to be responsible
A single overdraft won’t wreck your credit score, but it’s a slippery slope you want to avoid.
If you delay repayment for too long, your bank can easily become a collections agency, which can affect your credit score.
So rather than accumulate overdraft fees, take active steps to prevent overdrafts including making and sticking to a budget, and automating your bill payments.
Remember to monitor other factors affecting your credit, like payment history and utilization.
What are the negative effects of overdrafts?
Overdraft fees can add up quickly, increasing your overall banking costs.
Plus, relying on overdrafts can make it tough to stick to a balanced budget and lead to bigger financial headaches later.
Does a negative bank balance affect credit score?
Generally, a negative bank balance will not directly impact your credit score. However, the consequences of chronic overdrafts can do so.
If your bank cannot recoup the overdrawn funds and refers the account to collections, this delinquency will be reported to credit bureaus and can lower your credit score.
Do bank accounts show up on credit reports?
No, your standard checking or savings account activity doesn’t appear on your credit report.
Credit reports typically include information on loan accounts, credit card balances, and any public records related to delinquencies or bankruptcies.
But, remember, if your overdrafts go to collections, that will show up and bring down your score.
