Is it Bad To Be In My Overdraft?
Overdrafts are often misunderstood, mismanaged, and misused.
While it is possible to manage your overdraft well and build your credit score, it’s also possible for an adverse reaction to happen. If you go into an unarranged overdraft or stay in your overdraft, you can negatively impact your credit score in the long run.
What Is An Overdraft?
If you have a current account with your bank, you will likely have the option of having an overdraft. This acts as a buffer of extra money which can help out in emergency situations. It allows you to withdraw money or pay out money from your bank account even when you have run out of money in the account itself.
For example, if you only have £25 in your account but need to pay a £100 bill, an overdraft will allow you to pay the bill, and your balance would be -£75. This might seem like the bank is helping you out in a tight spot, but banks don’t do anything for nothing.
What Types Of Overdrafts Are There?
There are two different types of overdrafts: authorised and unauthorised. Authorised overdrafts are ones which require an application and approval from your bank.
Unauthorised overdrafts happen when you spend more than you have in your bank account without agreeing it in advance. You will also go into an unauthorised overdraft if you spend beyond the limit of your authorised overdraft.
How Much Does It Cost To Be In My Overdraft?
Charges on unauthorised overdrafts used to typically be much higher than charges for authorised ones. However, since April 2020, banks are no longer allowed to charge higher fees for unauthorised overdrafts. This has made overdrafts far more appealing.
Instead, interest for all overdrafts is charged at a single annual interest rate (APR). For consumers, this makes it much easier to compare charges between different accounts.
For overdrafts from banks and building societies, interest rates can range between 19% to 40% or more. These are insane interest rates that should make you weep. Going into overdraft can become a vacuum to future income as it goes straight to repaying the overdraft's initial amount and the ridiculous interest.
Do I Need An Overdraft?
An overdraft can act as a useful buffer to cover unexpected expenses.
However, overdrafts are for short-term solutions or emergencies only. It is when they are misused that they can become problematic. Considering the interest rates attached to them, you shouldn't want to use an overdraft at all.
People often underestimate the extent to which they are relying on their overdrafts, and, as a result, it can cost them much more than they expect.
If you find that you are constantly relying on the buffer, you may find it cheaper to take out a personal loan. Also, consider budgeting better to avoid needing a buffer at all.
What Happens If I Stay In My Overdraft?
If you are able to manage your overdraft well, it could help you build your credit score. However, if you end up in your unarranged overdraft and are unable to get out of it quickly, it could negatively impact your credit score and jeopardise your chances of getting credit in the future. That’s the thing about overdrafts that they’re extremely helpful in the moment but the complete opposite in the long run.
How Can I Use An Overdraft Responsibly?
If you choose to take out an authorised overdraft, you will have a certain limit each month. The key is to never exceed your limit and pay it off each month. If you do this, it can positively build your credit score as it shows that you are staying within your credit limit and making regular, punctual payments.
How Can An Overdraft Affect Your Credit Score?
An overdraft is a type of debt that will appear on your credit report. If you have an overdraft but don’t use it, it will show a zero balance. However, if you are in your overdraft, the amount that you owe will appear on your credit report.
When you use your overdraft responsibly, it is unlikely that it will impact your credit score dramatically.
In fact, if you regularly pay off your balance and use it sensibly, you could improve your credit rating as it demonstrates that you can handle debt, stay within your limit and make payments in full and on time. Thus, you paint the picture that you are a reliable borrower.
However, if you have used your unauthorised overdraft or have incurred charges for late payments, this will appear on your credit report and could negatively impact your credit score. If you have an authorised overdraft and regularly go over the limit, it presents you as unreliable with credit.
Conclusion
In summary, being in your overdraft isn’t necessarily a bad thing, though it can be. If you rely on it to cover living expenses, ensure you have a plan to pay it back on time.
Managing your finances is an important part of being an adult, and ensuring you borrow any money responsibly is a key part of this. Overdrafts aren’t dangerous, assuming they're used in the right way.
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