Got a current account? Then there’s a chance you might have the option of adding an overdraft to it. An overdraft is a pot of extra money, which you can dip into if your account runs dry.
It can come in really handy if things get a bit tight every now and then, but bear in mind you may have to pay interest or fees to use it. Make sure you use your overdraft carefully, otherwise your credit score could suffer.
An overdraft is a type of credit on your current account - it lets you pay bills or take out money, even when there’s no actual cash in your account. When you do this, you’re effectively borrowing money from the bank - that’s why it’s classed as ‘credit’.
Just having an overdraft isn’t likely to affect your credit score very much, but the way you use it could do - in both positive and negative ways. Just like any other type of credit, the way you manage your overdraft matters, because it could affect your finances in the future.
The difference is pretty straightforward, and the clue’s in the name.
An arranged overdraft is one that you’ve applied for (maybe as part of the process when you originally opened your account), and has been agreed with your bank. There’s a set amount of money you can borrow, up to a specific limit.
On the other hand, an unarranged overdraft is one that your bank might let you use, even though you haven’t applied for it, or if you go over the agreed limit of your arranged overdraft. Unarranged overdrafts will incur the same interest rate as an arranged overdraft, so it’s worth checking with your bank to make sure you are aware of how much you may be charged if you go overdrawn.
That depends! An overdraft can be a powerful thing, and the effect it has on your credit score comes down to how you use that power.
Going over the agreed limit on your overdraft will push you into unarranged overdraft territory, which is not a good place to be. From a lender’s point of view, it can make you look like you’re not in control of your spending, or that you’re not managing your finances very well, so it can bring your credit score down a few points.
Not paying off your overdraft, or being overdrawn for months on end, could also knock your score down for the same reasons.
On the other hand, using your arranged overdraft sensibly and making sure to clear it as soon as you can could have the opposite effect, and could actually give your credit score a boost.
Not to sound like a cheesy motivational speaker, but an overdraft is a great opportunity to show prospective lenders what you can do. It can be your secret weapon to build up your credit score, and show how responsible and reliable you are.
To do this, make sure you always stay within your agreed overdraft limit, and pay it off regularly. If you do this consistently over time, this will show any future lenders that you’re a reliable borrower, and that you can stay on top of your finances.
If and when you come to apply for credit in the future, the lender will take all of your unsecured borrowing - i.e. any debt that’s not a mortgage - into account (no pun intended). This includes your overdraft, so staying on top of it and managing it responsibly now could do you a big favour in the future.
Whilst an overdraft can be really handy, there’s no rule that says you have to have one. If your bank offers you one, it’s perfectly fine to say ‘thanks, but no thanks’.
If you’d rather steer clear of overdrafts altogether, it’s worth figuring out a strict monthly budget to make sure you live within your means, and don’t spend more than you earn.
Alternatively, if you like the idea of a back-up plan, but don’t fancy an overdraft, you could consider a credit card as a possible option. Many cards come with lower interest rates than overdrafts, but make sure you weigh up all the pros and cons before you apply, and always read the small print.
In many ways, your credit score is the key to your whole financial life. It influences everything from your chances of getting approved for a loan, credit card, mortgage and even (ahem) car finance. Or whether you can take out a phone contract or pay monthly for your car insurance. So it’s super important to take good care of it, like a treasured houseplant.
Luckily, credit scores are a little easier to look after than houseplants (we think so, anyway). Here’s some basic tips to consider to ensure yours is thriving:
Finally - be patient! Building up a strong, healthy credit score takes time, but if you keep doing the right things and stay consistent, you’ll reap the rewards down the road.