Imagine that your office laptop is broken and you urgently need a new one. If you have an overdraft on your card, you won’t have to wait for your next paycheck. You can buy a new laptop for work, and the bank in turn will withdraw the money you spent as soon as your paycheck arrives on your card.
So, here is more about overdrafts and how they affect your credit score.
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What does overdraft mean
An overdraft is the same as a credit. The bank grants it on certain conditions: it stipulates the maximum credit amount, the interest on it, the interest-free period (if any), penalties, and fees in case of default. Most often the overdraft is used when there are some unforeseen expenses and you need to borrow some until the salary. But if the overdraft limit allows, you can use it to make large purchases. But overdrafts have differences from consumer credits and credit cards.
What are the special features of an overdraft
The main difference is that it applies to debit cards. And only for salary cards or those to which payments are regularly received. It is a guarantee for the bank that the overdraft will be repaid on time. Sometimes overdrafts are available on credit cards as well. It allows you to go beyond the credit limit by a certain amount, but it’s more of an exception.
There are also other features:
- Term. A credit can be issued for several years, and credit card payments can be stretched over several months. Overdraft arrears are only allowed within a month and less frequently two months. During this time you have to pay off the overdraft in full. Then you can use it again.
- Amount. A credit or credit limit on a credit card can be several times your average monthly income. An overdraft limit is almost never more than twice your regular income.
- Amount of payment. Both the credit and the credit card debt are usually repaid in equal installments, gradually, according to a payment schedule. In this way, repayment of the entire debt can be stretched over several months or years. Overdrafts are paid off automatically and in full. As soon as money arrives in the account, the first thing the bank does is write off the entire amount of the overdraft.
- Interest. Interest on overdrafts is usually higher than on credit cards and even more so on credits. But since overdrafts are repaid very quickly, overpayments are small. Sometimes banks offer overdrafts with a grace period. If you want to repay the debt within a certain period, usually up to 30 days, no interest will be charged.
Do bank overdrafts affect credit score
Your checking account information isn’t regularly reported to the credit bureaus. That’s because you’re spending your own money, not money borrowed. Fortunately, bank overdrafts don’t affect your credit history if you resolve them in a timely manner. Once you pay off your overdraft and bring your account balance to at least zero, you can continue to use your checking account as normal.
However, if you never pay off your negative overdraft balance, your outstanding balance may be turned over to a collection agency for further action. At that point, the collection agency will report the debt to the credit bureau and it will be added to your credit report. Collecting the debt incurred as a result of the overdraft will affect your credit rating.
If you apply for a larger overdraft, your bank may do a hard search on your credit history. This can cause your credit rating to drop by several points within a few months. Using a larger overdraft will result in more total debt and therefore a lower credit rating. Consider your overdraft as a limit, not a goal. However, it will be much better for your credit rating if you negotiate a larger overdraft with your bank rather than going over the smaller limit without asking.
