Does overdraft affect your credit score?
Bank account overdrafts can happen to anyone regardless of their earnings. For example, someone might have a deferred deposit that arrives at their bank after an automatic withdrawal.
But what happens when you overdraft your bank account? What are the potential direct (or indirect) effects of an overdraft on your credit score?
What is an overdraft?
“Overdraft” is the term given to someone He does not have enough money in the account to cover expenses At the time of withdrawal (i.e. through automated payment or check). What happens when an account is overdrawn will depend on the bank/lender’s policies.
For example, the bank may reject the transaction and charge the account holder a non-sufficient funds (NSF) fee. NSF fees can be quite high, with most Canadian financial institutions charging $45 per transaction. In this case, not only will your transaction not go through (resulting in an unpaid debt), but you will also owe an additional $45 to your financial institution.
If you have overdraft protection, overdrafting your account works a little differently.
What is overdraft protection and how does it work?
Overdraft Protection is an optional service that allows you to overdraft your bank account balance if you do not have enough money to cover a financial transaction. The bank lends you the amount you lack. It can cover transactions such as debit purchases, bill payments, checks, withdrawals, and bank account transfers. This can help you avoid rejected transactions and NSF fees.
If you sign up for overdraft protection with your financial institution, your bank will provide a small ‘loan’ to allow the purchase to be completed. In order to get overdraft protection, you must apply through a credit application. If you’re approved, the bank will set your limit based on your creditworthiness, and when you go into an overdraft, the bank will charge you an overdraft fee, usually around $5, plus applicable overdraft interest fees.
Some banks may have a form of overdraft protection that allows you to link your account to another financial product and withdraw funds from that other product to cover the overdraft. For example, if you have a checking account and a savings account at the same bank, they may have a policy in place that uses the balance in your savings account to cover an overdraft in your checking account. Another financial product you can tie into is a line of credit. The bank may charge a fee for this service – although it varies from one bank to another and even from one type of linked financial product to the next.
How does an overdraft happen?
Overdrafts can occur for several reasons. For example:
- Making a purchase assuming the deposit has been settled when it has not.
- Forgetting about an outstanding check that has not yet been cashed while making purchases from the same account.
- Sudden and unexpected emergencies that cost more than you have allocated in your emergency fund.
- Automatic renewal of subscription services or late payments you forgot cause you to overestimate how much money you have available.
- False or fraudulent charges that you cannot account for because you did not know about them or their value.
These are just a few examples of situations that may lead to an overdraft. In some cases, you may be able to work with your bank to resolve an overdraft issue and avoid fees — especially if you can prove that the charges were false or resulted from fraud.
Overdrafts and credit scores: Direct influence
What happens to your credit score if you go into overdraft? The short answer is nothing. An overdraft will not have an immediate impact on your credit score.
If you have some form of overdraft protection that covers overspending so your account doesn’t default — or if you’re able to pay off the missing money before the end of your bank statement period — you shouldn’t see an impact on your credit score just from overdrafting it. Exposed.
“While it can be beneficial, it is important not to rely on an overdraft because it is a form of credit. Regularly relying on an overdraft is a warning sign that you are not on the right track with your budget. If you find yourself relying on a Overdraft, go back to the ABCs of budgeting – analyze, brainstorm, and change Analyze your expenses by making a list of all your expenses Brainstorm ideas to reduce spending and/or increase income Change your spending and/or income based on what you choose to do with During brainstorming.
– Becky Western Macfadyen, Director of Financial Training, Credit Canada
Indirect consequences of overdraft
While overdraft or NSF fees do not have an immediate and direct impact on your credit score, it is possible that there not directly Consequences of not having sufficient funds in your account.
Bank balances are sent to groups
For example, if your account has had a negative balance for a very long time (usually 60-90 days), it may be sent to collections. This may show up as a negative event on your credit history and lower your credit score.
To avoid this, it is important to repay the withdrawn bank balance as soon as possible.
Unpaid debts resulting from returned check/card transactions
Let’s say you wrote a check that bounced due to insufficient funds. The returned check itself will not be reported to the credit bureau. However, an unpaid balance may be reported to the credit bureau as an outstanding debt and hurt your credit score.
If your bank reports a check bounce and you haven’t heard from the company you sent the check to yet, contact them as soon as possible to set up an alternative payment arrangement.
7 tips to manage your overdraft effectively
So, what can you do to avoid overdrafts and reduce the impact of overdrafts on your credit score? Here are some tips that can help:
1: Ask what type of protection your bank offers
When setting up a new bank account, check to see what type of overdraft protection the product offers. For example, can you set up automatic transfers from a savings account to a checking account? What are overdraft protection fees?
Knowing how an overdraft on your bank account works can help you avoid or prepare for any associated costs or impacts.
2: Track your monthly income and expenses
The best way to deal with an overdraft is to avoid it in the first place. One way to do this is to use a budget planning and expense tracking tool to check how much money you make each month versus how much you spend (and what you spend it on).
This can help you more accurately assess how sustainable your current spending habits are and identify areas where you can make reductions. Knowing this can help you avoid overdrafts because it enables you to ask yourself: “Can I really afford this?” And get a clear answer.
3: Cancel auto-renewal subscriptions
How many subscriptions are renewed each month for services you don’t use? Multiple small transactions can cost you a lot when you are overdrawn. For example, let’s say your bank has an overdraft fee of $5 for every transaction that occurs while your account balance is negative.
While you wait for your deposit to clear, each transaction you make will cost an additional $5 – making your $9.99 Netflix subscription $14.99 instead.
4: Create a monthly budget and stick to it
After tracking your income and expenses, create a monthly budget of what to spend and what to spend it on so that all your needs are met, and your debt payments are made. Any money left over after your needs are met can be put aside in your savings, invested, or allocated to your “rainy day” fund.
Track how prices of goods you routinely purchase change over time. This way, you can adjust your budget to take inflation into account on these expenses.
5: Follow up with companies after receiving NSF notification
It is likely that if the transaction is declined due to insufficient funds, the company you are interacting with will inform you of this. However, it’s easy to miss an email or get a message lost in your voice mailbox. Therefore, when you receive an alert from your bank informing you that a transaction has been declined, it is important to verify the reason for the transaction and follow up with the company to resolve the issue.
For example, suppose a debt payment was missed due to insufficient funds. By proactively communicating with your creditor, you can take care of payment or make an alternative arrangement before the bill becomes delinquent and hurts your credit score.
6: Frequently check your bank balance and transaction history
Before making large purchases, log in and check your current bank account balance and recent transaction history.
Frequently checking your online bank account and verifying that it reflects your recent transactions before making a purchase can help you avoid inadvertently overdrawing your account.
7: Challenge fraudulent accusations as soon as possible
If you see a charge on your bank account that you know you didn’t approve of, dispute it as soon as possible. If necessary, contact your bank and ask them to replace your credit/debit card to prevent the scammer from charging your account more fees which could lead to an overdraft.
The sooner you do this, the better, because it helps you avoid false charges. Also, if you incur overdraft fees due to fraud, your bank should work with you to remove the fees from your account. You should not be liable for transactions that you did not make or approve.
Conclusion
Monitoring your bank accounts to check that you have enough money to cover your costs – and identifying ways to reduce your spending based on your income and necessary expenses – can be an invaluable way to avoid an overdraft problem. While an overdraft does not directly affect your credit score, having a negative bank balance or missing principal payments due to insufficient funds Can Affect your credit score.
Managing your money is the best way to prevent overdrafts and save money to get out of debt (and stay in it) while building your credit score.
If you find that you’re constantly overdrafting your bank account or struggling to keep up with the minimum monthly payments on your debts, help is available. Contact Credit Canada for information about debt relief options and how you can live a debt-free life.