Does an Overdraft Affect Your Credit Score?

An overdraft is an excellent financial buffer, should you ever be low on funds. It usually doesn’t cost you anything if you don’t use it, and it’s inexpensive if you have to dip into it for short periods.

However, some people worry that using one might have a negative impact on their financial status, and affect their future borrowing ability.

You’re likely reading this because you want to know the answer to one question in particular: “Does an overdraft affect your credit score?” 

The following information will answer your question - read on!

How Credit Scoring Works

In a nutshell, credit scoring uses computerized algorithms designed by credit reporting agencies. These algorithms calculate results on a numerical scale from 300 to 850, known as the FICO credit scoring range.

As you can imagine, scores on the higher end of the scale represent a “good” risk level to lenders. In contrast, people whose scores are on the lower end of that same scale will find it challenging to get accepted for borrowing.

How An Overdraft May Impact Your Credit

Credit scoring takes into account all forms of borrowing offered by financial institutions. Every person old enough to borrow money with a high enough credit rating is eligible for an overdraft on their account. This sounds like a type of borrowing, right?

Well, overdrafts are an emergency safety net, and should only be used when no other options are available. However, many people routinely use them to cover unexpected costs and then pay them back as soon as they get some money.

While they are considered “irresponsible account use,” frequent checking account overdrafts do not impact a person’s ability to borrow money in the future.

In fact, no checking account behavior is reported to the credit agencies. However, overdrafts do come with potentially steep fees.

Checking Accounts Without Lending Options

Bank accounts without this “lending” option attached also exist, and if you don’t expect to need an overdraft, you might want to choose this type of arrangement.

It won’t affect your credit score, but it will stop you from irresponsible spending and potentially save you a bunch on fees.

Enabling Overdrafts

Overdrafts are not always automatically enabled, but this differs between banks. If you want to avoid having your payments rejected in a store, or something similarly embarrassing, you might want to ask your bank whether overdraft protection is part of your checking account package.

However, if you’re fastidious about spending and borrowing, you might just do fine without. What’s more, chances are, your bank might offer you all kinds of financial options - lending or otherwise - as they would consider the risk more than acceptable.

The last thing you should ever do is borrow money from any financial institution unnecessarily, and an overdraft is still a form of debt, even if it doesn’t reflect on your credit score. 

To help you discern whether you need one, here are some instances where overdrafts can make sense:

You Want To Have a Financial Buffer Zone

If maintaining your monthly balance tends to be precarious, you might want to have some extra financial peace of mind in case you need to pay for a large unexpected bill and you can’t transfer money from elsewhere to cover it in time.

You Have a Variable Monthly Income

Overdrafts can help those with varying monthly income. For example, if you’re paid on a project basis, instead of a fixed schedule, overdraft protection will help you ensure the basics are covered each month.

Should I Keep My Overdraft Protection?

Is this option standard at your bank, or have you enabled it just in case, but found you never use it? Here’s when disabling this feature is reasonable:

You Have a Large Regular Income

If you earn more than enough money each month, it’s highly unlikely you’ll need to use this form of borrowing. Instead, you might want to direct some of that money into a high-yield savings account.

Your Income Is Low

Oddly enough, if you’re in a lower income bracket, overdraft protection is also often a bad idea. While it can provide an important safety net from unexpected expenses, overdraft fees can spiral out of control, and you may end up dealing with additional financial problems.

In 2020, US banks charged people around $12.4 billion in overdraft fees. In other words, you want to avoid getting bogged down by unpaid bank fees from your overdrafts and becoming a part of the growing consumer debt problem.