Will overdraft fees damage your credit?

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Will overdraft fees damage your credit?

Rounding it up

  • Overdrafts are helpful when you’re on a tight budget. They allow you to make transactions when your account is overdrawn.

  • Since overdrafts are in your bank account and not in a borrowed account, they’re not reported to the credit bureau and therefore cannot affect your credit score.

  • However, when your account reads negative for too long, it may be sent to collections, and this will affect your credit score.

4 min read

Joseph Iyanu
#overdraft fees#credit#debt management

Many people use overdrafts, especially those with low to average monthly income and tight monthly budgets. Overdrafts can come in handy when your accounts are overdrawn, allowing you to make payments. These overdrafts do not directly affect your credit score as long as you repay the overdrafts and other related fees on time.

In cases where you don’t pay these overdrafts on time, they still may not affect your credit score. But over-reliance on them may lead to you accumulating these overdrafts for too long, affecting your credit score. When your account reads negative for too long, it may trigger your bank to send it to a collection agency, which will reflect on your credit score once it’s reported to the credit bureaus.

Will Overdraft Fees Damage Your Credit?

Generally, when you have a chequing account, you can spend whatever amount you have in the account. Furthermore, after spending your available balance in your account, you can still make transactions and payments with an overdrawn account. Overdrafts make this possible. For example, if you have $500 in your chequing account and have exhausted that amount, the next time you try to spend $20, the bank will allow you, but it would send your account into the negative. However, there is an overdraft fee attached to the extra $20 you spent, which you must pay back to return your account to a zero balance or higher. Sometimes, you may have to pay more if this fee exceeds a given period. None of these reflects on your credit score.

Since it’s a chequing account and not borrowed money, your bank doesn’t report overdrafts to the credit bureau. Bank overdrafts don’t affect your credit score so long as you resolve them appropriately. However, if you ignore them for too long, your negative balances will be sent to a collection agency, which will negatively impact your credit score. This is avoidable. You can avoid overdraft fees by avoiding overdrawing your accounts. This post will educate you on ways to avoid overdraft fees and overdrawing your account.

Will My Chequing Accounts Appear on My Credit Report?

Ideally, all your credit cards and loan information appear on your credit report to show that you are borrowing and returning the money. However, since it is a chequing account, money is pulled from your debit cards, and you are not borrowing money. To this end, your chequing account does not appear on your credit report.

This implies that the overdraft will not be reflected on your credit report even after spending more than your available balance and incurring an overdraft fee. However, this doesn’t mean you should leave them unchecked, as they can still affect your financial health and credit score.

Banks have a system in their database that allows them to track details about the account. They can see information on your financial activities, including: how often you take overdrafts, how many cheques you’ve bounced, balances you’ve left unpaid, how many involuntary account closures you’ve had, and what, if any, fraudulent activities you’ve been involved with.

In cases where your cheques consistently bounce or you are too reliant on overdrafts, the bank may conclude that you are financially overextended. As a result, they deny certain financial services like credit cards and loans.

How Does Overdraft Affect My Credit Score?

An overdraft happens when you make a debit card payment or write a cheque for an amount that exceeds the amount of money you have available in your account. The bank can either approve or decline your overdraft based on certain policies. In addition, there is a limit to extending your money, but this limit doesn’t restrict you from overdrawing your account more than once. When you consistently rely on overdrafts, they can pile up fast, and as a result, issues might arise.

In cases where the bank approves your overdraft, you must pay back the overdraft amount plus the overdraft fee to the bank within a certain amount of time. You have to do this as soon as possible to return your chequing account to positive. Meanwhile, your credit may still look positive if you don’t pay back the overdraft amount and the overdraft fee before or at the time it is due. However, when you do this repeatedly, and your overdrafts begin to accumulate, or your chequing account is negative for too long, you unconsciously begin damaging your credit score.

Overdrafts become a problem to your credit only if you don’t pay them and other associated fees when due. When overdrafts exist for too long, the bank classifies them as unpaid debts and sends them to a collection agency. Once this debt goes to a collection agency, the information is reported to the credit bureaus, and your credit score suffers. In addition, once delinquency on your credit is reported to the credit bureaus, it remains there for seven years, and this is something none of us want to experience.

Now, your bank doesn’t report overdrafts to the credit bureau, nor does the credit bureau track your account for debt. However, if you have a consistent overdraft in your account, it will reflect in your debit bureau report, which is bad for your financial health. It denies you certain financial benefits like opening a second bank account or investing in credit default swaps and mutual funds.

On the other hand, in the event that your bank declines your overdraft, you must settle the transaction with the payee. Bounced cheques are a suitable example here. Say you write a cheque for a utility company or your landlord, and it bounces. You have to resolve and settle the transaction with them to avoid having it reported to a credit agency. If your cheques bounce too many times, and the payee reports you to the collections or the credit agency, the result negatively impacts your credit.

Maintaining a good credit score is essential. You should watch out for other factors that might damage your credit. One of them is the payment history. You don’t want to be late on payments, as late payment may indicate that you are undisciplined with your finances, and that will leave a negative mark on your credit.

Should I Accept Overdraft Protection?

Overdraft protection is a service that banks, credit unions, and financial institutions in general use that allows customers and clients to overdraw their chequing accounts. It allows your cheques and transactions to clear and go through even if you don’t have enough money in your account to cover that transaction. Overdraft protection can be very helpful, but it also has its disadvantages. You should be familiar with the pros and cons of overdraft protection before you accept or decline it.

Overdraft protection gives you immunity to some unfavourable consequences like late payment fees, merchant fees, and the fees an individual or business may charge you for a bounced cheque. However, you must understand that these financial institutions usually attach a fee to every transaction they cover for you using overdraft protection. This fee can quickly accumulate if left unchecked.

Even with overdraft protection, there is still an overdraft limit. There is a maximum amount you can overdraw from your account. You can opt-in for overdraft protection when you open your chequing account or at any other convenient time.

How Can I Avoid Overdrafts?

You can avoid bank overdrafts when you accept bank overdraft protection. There are also other ways to avoid overdrawing your account. Below you will find useful tips to avoid bank overdrafts.

  • Linking Your Credit Card to Your Chequing Account

Generally, the bank allows an overdraft when you make a transaction greater than the balance in your chequing account. When you link your credit card to your chequing account, it’s deducted from your credit card instead of the bank charging the extra amount as an overdraft. However, you must be mindful of this as some financial institutions classify this type of transaction as a cash advance, and cash advances attract higher interest rate with no grace period.

  • Linking Your Savings Account to Your Chequing Account

This right here is quite similar to what you read about above. The excess amount is covered from your savings account and not charged as an overdraft. However, you must watch your savings account balance closely so it doesn’t hit zero.

  • Monitor Your Account

You can set up an application or a system to alert you on your balance and transactions. This way, you can have records of your transactions and balances and not be caught off guard with insufficient balance. However, you must ensure the application or system you use is affiliated with your banking institution.

  • Stick to a Budget

Budgets may be hard to stick with as prices are not always stable. However, you can practice the habit of cautiously spending, so you don’t exceed your budget.

  • Sign Up for Alerts

You can sign up for email notifications or alerts via SMS to know when your checking account balance slips below a set amount.

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