How Overdrafts Impact Your Credit Score and Mortgage Approval
Overdrafts are a common financial tool used by many people to manage short-term cash flow issues.
However, if you’re considering applying for a mortgage or other forms of credit, you may wonder how your overdraft usage might affect your credit score.
At Kerr & Watson, we specialise in providing mortgage and protection advice, ensuring our clients make informed financial decisions.
What Is an Overdraft?
An overdraft is a facility provided by banks that allows you to withdraw more money than you have in your account, up to an agreed limit. There are two types of overdrafts:
Arranged (Authorised) Overdraft: This is an agreed-upon limit with your bank, allowing you to borrow up to a certain amount.
Unarranged (Unauthorised) Overdraft: This occurs when you exceed your arranged overdraft limit or overdraw without an agreed overdraft in place.
Key Features of Overdrafts
Interest Rates: Overdrafts often come with high-interest rates, especially for unarranged overdrafts, being costly over time.
Flexibility: They offer immediate access to funds, making them useful for unexpected expenses when getting through the month.
No Fixed Repayment Schedule: Unlike loans, overdrafts do not have fixed repayment schedules, but banks expect regular payments to cover the overdrawn amount which is also beneficial for the borrower.
Find out Your Options
How Overdrafts Affect Your Credit Score
Using an overdraft can have both positive and negative impacts on your credit score, depending on how you manage it.
Positive Impacts
Credit Utilisation: If you use your overdraft responsibly and stay within the agreed limit, it can demonstrate good credit management, potentially boosting your credit score as you pay your creditors on time and do not take too much debt.
Credit History: Regular, responsible use of an overdraft can build a positive credit history, showing lenders that you can manage credit effectively.
Negative Impacts
High Usage: Frequent or prolonged use of an overdraft can signal to lenders that you may be financially unstable, which can negatively impact your credit score if it seems you have trouble getting through the month.
Unauthorised Overdrafts: Exceeding your arranged limit or frequently using an unauthorised overdraft can significantly harm your credit score. It indicates poor financial management and increases the risk for lenders when they lend you their money.
Debt-to-Income Ratio: High levels of overdraft usage can increase your debt-to-income ratio, making you appear riskier to lenders.
Managing Overdrafts and Improving Credit Score
Pay Off Your Overdraft
Clearing your overdraft can positively affect your credit score by reducing your overall debt. It also shows potential lenders that you’re capable of managing and repaying credit. Be sure to only do this if you are in a position to do so as it’s not always guaranteed to get you a mortgage. It’s best to speak with a broker for professional advice.
Avoid Unauthorised Overdrafts
Staying within your arranged overdraft limit is important. Unauthorised overdrafts not only attract high fees but also negatively impact your credit score.
Use Overdrafts Sparingly
Overdrafts should be used as a short-term solution, not a long-term financial strategy for living in. Relying heavily on an overdraft can indicate financial distress, which can be a red flag for lenders.
Regularly Monitor Your Account
Keep track of your spending and be aware of your account balance to avoid slipping into an unauthorised overdraft. Many banks offer alerts or apps to help you manage your finances effectively. You can get a free trial to vie your credit score with Check My File.
Overdrafts and Mortgage Applications
Impact on Mortgage Approval
When applying for a mortgage, lenders will assess your overall financial health, including your credit score, income, and debt levels. While having an overdraft isn’t necessarily a deal-breaker, how you manage it can influence a lender’s decision to lend to you.
Conclusion
Using an overdraft can impact your credit score and, consequently, your ability to secure a mortgage. Responsible management of your overdraft and overall finances is crucial in maintaining a healthy credit score and demonstrating financial stability to lenders.
If you’re concerned about how your overdraft might affect your mortgage application or need advice on managing your finances, contact Kerr & Watson today.
