Overdrafts! What are they and how can they affect your credit score? 

Whether you're a financial newbie or looking to improve your credit score knowledge, this is just what you’re looking for.

What is an Overdraft?

An overdraft is a service provided by your bank that allows you to withdraw money or run up expenses beyond the available balance in your account. The overdraft is a pre-approved limit set by your bank. This acts as a short-term financial buffer. 

There are two main types of overdrafts:

• Authorised Overdrafts: These are the overdrafts that are pre-agreed with your bank, providing a safety net up to a certain limit (like the one we mentioned above). They usually involve lower fees and interest rates.
• Unauthorised Overdrafts: These occur when you exceed the authorised limit or haven't arranged an overdraft in advance. They typically attract higher fees and can show financial mismanagement as you have needed ‘extra’ cash that goes beyond your agreed safety net. 

How Does an Overdraft Appear on Your Credit Report?

Your credit report is a history of your financial management and behaviour. For more detailed information about What is a Credit Score, and How to Navigate Credit Checks, check out our dedicated articles to get you up to speed.

Overdrafts show up on your credit report as a line item, which is a distinct element of your credit history. But here's the catch: if you use your overdraft and pay it back quickly, it might not even make it onto your report. Most banks send updates to credit agencies once a month, so pay it off on time and it is unlikely to show up.

Positive Impact of Overdrafts on Credit Score

Here's some good news: using an authorised overdraft wisely can give your credit score a little boost. The trick is to use it just a bit and always pay it back fast. This way, you're telling the world that you can manage money and your expenses.

Risks of Overdrafts: When They Can Harm Your Credit Score

However, overdrafts can be a slippery slope. If you're constantly ‘in the red’ (so exceeding your available funds) or even dipping into an unauthorised overdraft, it's like waving a red flag at your credit score. It tells lenders you might be struggling with cash and managing your expenses.

Two Top Tips for Managing Your Overdraft

So, how do you use an overdraft like a pro? Keep these pointers in mind:

• Stick to the limit your bank gave you.
• Payback Time: Borrow it, use it, return it – fast. 

It is a good idea to see an overdraft as a short-term loan, that should be paid back as quickly as possible. If you are going up to or even beyond your overdraft limit frequently, it sounds like it might be worth checking some ways to budget - that aren’t all spreadsheets and ‘going without’.

Overdrafts and Major Financial Decisions

Your overdraft habits don't just stay in your account; they can influence big life choices. Planning to buy a car, or even a house? Lenders will have a look at how you handle your overdraft. If they see you're always maxing it out, they might think twice before saying yes to a car finance agreement or a mortgage. 

Overdrafts can be a nifty financial tool, so long as you play by the rules! They can even help polish up your credit score. But remember, the key is smart and swift use.