Does an Overdraft Affect Your Credit Score?

An overdraft occurs when you spend more money than you have available in your checking or savings account. While an overdraft itself doesn’t always directly harm your credit, specific circumstances can lead to negative consequences. This article clarifies the relationship between overdrafts and your credit score.

Understanding Overdrafts

An overdraft effectively means your bank account balance falls below zero, resulting in a negative balance. When this happens, the bank generally has two choices: either it declines the transaction, or it covers the amount, essentially extending a short-term loan to you. This decision often depends on the type of transaction and whether you have opted into specific overdraft services.

Banks offer various ways to handle situations where funds are insufficient. Overdraft protection services allow you to link your checking account to another account, such as a savings account, a credit card, or a line of credit, to cover shortages. If you overdraw, funds are automatically transferred from the linked account to prevent the transaction from being declined.

In contrast, standard overdraft fees are incurred when a transaction overdraws the account without such protection, or when the protection limit is exceeded. These fees, which can average around $35 per transaction, are charged by the bank for covering the overdrawn amount. Overdrafts commonly occur with debit card purchases, ATM withdrawals, checks, or automated clearing house (ACH) payments.

Overdrafts and Your Credit Score

A single overdraft or its associated fee typically does not directly affect your credit score. This is because checking and savings account activity is generally not reported to the three major credit bureaus—Experian, Equifax, and TransUnion. Your credit report primarily tracks borrowing and repayment of loans and credit cards.

The primary way an overdraft can negatively impact your credit score is indirectly, specifically if the unpaid overdraft balance, including any fees, is sent to a collections agency. When a debt goes to collections, it is reported to credit bureaus as a delinquency and can significantly damage your credit score, potentially remaining on your credit report for up to seven years. The impact’s severity depends on factors like the amount owed and how long it remains unpaid. Financial institutions may send an unpaid overdraft to collections if the negative balance is not resolved promptly.

Specialty consumer reporting agencies like ChexSystems track checking account activity. ChexSystems collects information on issues such as overdrafts, bounced checks, and unpaid negative balances. While a ChexSystems report does not affect your standard credit score, a negative history with this agency can make it difficult to open new bank accounts, as many financial institutions use these reports to assess risk.

Strategies to Manage Overdrafts

Proactive management of your bank account can help prevent overdrafts. Regularly checking your account balances through online banking or mobile applications is a fundamental step, as it provides a clear picture of available funds. Remember that your available balance may not include all pending transactions, such as recently written checks or automatic payments.

Setting up low-balance alerts through your bank can provide timely notifications, allowing you to transfer funds or adjust spending before an overdraft occurs. Federal regulations allow you to opt-in or opt-out of overdraft protection for ATM withdrawals and one-time debit card transactions. If you opt out, these transactions will typically be declined if funds are insufficient, preventing an overdraft fee.

Linking your checking account to a savings account or a line of credit provides a safety net, as funds can be automatically transferred to cover shortfalls. While these transfers may sometimes incur a small fee, it is typically less expensive than an overdraft fee. If an overdraft does occur, addressing the negative balance and any associated fees promptly is important to avoid the debt being sent to collections, which would then impact your credit score.