Does Overdraft Affect Credit Score

Does Overdraft Affect Credit Score

An overdraft can be a helpful financial safety net, allowing you to spend a little more than you have in your current account. Many banks in the UK offer overdrafts as a form of short-term borrowing, either authorised (agreed in advance) or unauthorised (unplanned). But while dipping into your overdraft might help cover unexpected costs, it’s important to understand how this borrowing can affect your credit score.

In this article, we’ll explain how overdrafts work, the difference between arranged and unarranged overdrafts, and what impact they can have on your credit score. We’ll also cover how lenders view overdraft use, offer practical tips, and highlight what to watch out for if you're relying on your overdraft regularly.

What Is an Overdraft

An overdraft allows you to spend more money than you have in your current account, up to a set limit. In the UK, overdrafts are typically of two types:

• Arranged overdraft: Pre-agreed with your bank, with a set limit. You can use this facility as needed, often with daily or monthly interest charges.

• Unarranged overdraft: When you go beyond your account balance or your arranged overdraft limit without agreement. This usually comes with higher charges and is a red flag to banks and credit reference agencies.

Some banks offer a small interest-free buffer, especially to students, but most overdrafts are a form of high-cost borrowing and are reported to credit reference agencies.

Who Is Affected by Overdraft Use

Overdrafts affect a wide range of account holders in the UK:

• Students and young adults who are often offered interest-free overdrafts with student accounts

• Employees using overdrafts to bridge the gap between paydays

• Self-employed workers or freelancers managing cash flow

• Anyone on low or irregular incomes using overdrafts for essential expenses

If you regularly use an overdraft or exceed your agreed limit, your credit profile may be affected, potentially influencing future borrowing decisions.

How Overdrafts Affect Your Credit Score

Credit reference agencies like Experian, Equifax and TransUnion collect information from your bank about your account activity. Here's how overdrafts can influence your credit score:

1. Regular use of arranged overdrafts
Using an agreed overdraft occasionally and repaying it quickly may have little impact. However, frequent or prolonged use of your overdraft suggests to lenders that you're dependent on borrowing, which can negatively affect your credit score over time.

2. Exceeding your overdraft limit
Going over your agreed limit or entering into an unarranged overdraft can harm your credit report. Your bank may report missed payments or unauthorised borrowing, both of which are red flags for lenders.

3. Credit utilisation
Overdrafts contribute to your overall debt levels. Just like credit cards, high utilisation (using a large portion of your available credit) can lower your score.

4. Impact on affordability checks
Lenders may review your bank statements when assessing applications for mortgages, loans or credit cards. Persistent overdraft use could suggest you’re struggling with day-to-day expenses, reducing your chances of approval.

5. Reporting of account status
If your overdraft leads to your account being closed or referred to a debt collection agency, this will appear on your credit file and significantly damage your score.

Pros and Cons of Using an Overdraft

Pros

• Flexible and easy to access

• Can help with short-term cash flow problems

• Often cheaper than payday loans or unauthorised borrowing

Cons

• High interest rates compared to other credit products

• Can reduce your credit score if used excessively or unarranged

• May lead to dependency or financial instability

• Difficult to break the cycle if used regularly

Real-World Example

Sophie had a £500 arranged overdraft that she occasionally used in the week before payday. Her credit score remained healthy because she never exceeded the limit and repaid it quickly.

James, on the other hand, had a £1,000 overdraft which he used consistently, often reaching the limit and staying in the red for months. This long-term reliance on overdraft borrowing led to a noticeable drop in his credit score and made it harder to get approved for a personal loan.

Legal and Regulatory Context

Overdrafts are regulated by the Financial Conduct Authority (FCA), which introduced stricter rules in April 2020. These rules aimed to make overdrafts fairer and more transparent:

• Daily fees replaced with single interest rates

• Unarranged overdrafts must not be more expensive than arranged ones

• Banks must advertise overdrafts clearly and consistently

Banks must also report account information to credit reference agencies, including overdraft limits, usage and any missed payments.

You’re entitled to access your credit report from all three UK agencies and challenge any errors. Overdrafts, like other credit agreements, usually stay on your credit file for six years.

Cost of Using an Overdraft

Most UK banks now charge interest on overdrafts at a flat annual percentage rate (APR), commonly around 35 to 40 percent. There may also be charges if you exceed your limit, although these have become less common since FCA reform.

Some student accounts offer interest-free overdrafts, typically up to £1,500. However, these revert to standard rates after graduation, so it's essential to repay before your grace period ends.

Over time, overdrafts can become one of the most expensive forms of borrowing if not repaid quickly.

Alternatives to Overdrafts

If you're relying on your overdraft regularly, consider these alternatives:

• Budgeting tools like Monzo or Starling to track spending and prevent overspending

• Low-interest personal loans for planned borrowing with fixed repayments

• Credit cards with 0 percent purchase offers (if used responsibly)

• Savings accounts to build an emergency fund and reduce reliance on credit

For those with poor credit, consider speaking to a debt adviser or using a credit union.

Practical Tips to Minimise Credit Impact

• Only use your overdraft in emergencies or for short periods

• Repay it in full each month if possible

• Avoid using the full limit regularly – aim to stay under 50 percent of your limit

• Check your credit report to ensure accurate reporting

• Speak to your bank if you're struggling – they may offer a repayment plan or temporary support

Final Thought

An overdraft used occasionally and within limits is unlikely to cause serious harm to your credit score. However, consistent or excessive use, especially of unarranged overdrafts, can signal financial stress and lower your creditworthiness.

Lenders and banks are increasingly scrutinising overdraft behaviour, so treat it like any other borrowing. Plan ahead, use it wisely, and if you're struggling to break free from overdraft dependency, seek advice and explore more sustainable options.