Does Overdrafting Affect My Credit Score?

It can happen to the best of us. A transposed number when balancing our checkbook. An entry we forgot to write in or enter into our online check register. And before you know it, you’ve spent over the balance in your checkbook. The entire experience can leave you smacking your forehead and cringing in disbelief. But aside from those fees from your bank, you are likely wondering if over-drafting affects your credit score. The answer, thankfully, is no, but there are some other things you should be aware of.

Highlights & Key Takeaways

• Over-drafting on your check account will not directly impact your credit score, and it will not impact your ability to apply for credit cards or personal loans
• If you fail to pay your bank’s overdraft fees, they can send the amount to collections, which will hurt your credit score.
• You can manage your checking account balance and sign up for overdraft protection to avoid overdrafts and the associated fees. 
• If you overdraft on a check that was meant to pay off your credit card or personal loan payment and do not promptly make up the payment, the lender may report your poor payment activity to the credit bureaus

Does Overdrafting Hurt Your Credit Score?

As mentioned above, over-drafting your checking account will not hurt your credit score. This is because when you write a check or charge a transaction to the debit card associated with your checking account, you are spending funds that already belong to you. You are not purchasing on credit. Therefore, overdraft activity is not reported to the credit bureaus. That said, a history of overdrafts, low balances, and bounced checks can be reported to other systems that creditors may check when deciding your creditworthiness. 

The Negative Effects of Overdrafting on Credit Scores

Though over-drafting doesn’t impact your credit scores, you must be aware of two potential detrimental consequences. 

• Overdraft fees charged by your bank as well as the intended recipient’s bank
• Bounced check fees 

The truly unfortunate outcome of these events is that you can get hit with both overdraft and bounced check fees (also called insufficient funds fees) if your bounced check is what caused the overdraft. If you have a debit card that spends money against your checking account, you must be aware that those transactions can also cause insufficient funds. But, since you didn’t write a check that caused the overdraft, the bounced check fee will not apply.

This all said, bouncing a check or causing an overdraft can get expensive, and fast.

The Link Between Overdraft Fees and Credit Scores

When you overdraft your checking account, your bank will charge you a fee. These fees can vary from bank to bank but are typically around $35 per occurrence. As you can imagine, those fees can add up quickly if you are not paying attention. Many banks take the funds to pay those directly from your checking account, too, which can cause your account to go further into the negative. In other cases, the bank may send you a notice asking you to pay the fee, especially if the funds weren’t there for them to take them in the first place automatically. If you fail to pay those fees promptly, your bank could report your account to a collections agency.

Here’s where things get truly challenging. If your negative bank account is reported to a collections agency, not only will those collectors start calling you demanding payment, but this activity can and usually is reported to the credit bureaus. And once that collections activity is on your credit report, it can stay there for up to seven years. Whether your account is negative by $100 or $500, the entire situation can ding your credit score by as much as 100 points. Though you should pay off your collections account, unfortunately, doing so will not likely improve your credit score.

Bounced Checks and Your Credit Score 

To further complicate this complex situation, your bounced check may or may not indirectly impact your credit score. According to the Consumer Financial Protection Bureau (CFPB), banks and credit unions don’t typically report bounced check activity to credit reporting agencies. But, there are two scenarios where a bounced check will hurt you beyond the abovementioned fees.

• If you write bad checks often, the activity may be reported to a specialty credit-reporting agency specializing in checking information. An example is ChexSystems. 
• If you wrote a check towards a personal loan payment or credit card balance and don’t make good on that payment within 30 days, the lender may report your account to a credit bureau such as Experian, Equifax, or TransUnion.
• If you attempt to pay another type of bill with funds from your checking account, such as rent or utility, with insufficient funds, you also risk damage to your credit score because some of these companies may report your activity to the credit bureaus.

ChexSystems: An Additional Downside of Over-drafting 

Earlier, we mentioned that ChexSystems is a specialized credit-reporting agency that focuses on checking information. And, as you know, overdrafts are not listed on your credit report. But that does not necessarily mean there is no record of them. If you fail to pay your overdraft fee in a reasonable amount of time (usually within five to seven days), your bank may report your information to ChexSystems.

ChexSystems maintains a current report of your banking activity. If you want to open a new checking or savings account, the bank can contact ChexSystems for a copy of your report to see if it is a good idea. If you have negative information in your ChexSystems report, like the following, it might be difficult for you to open new checking accounts in the future.

• Involuntary account closure
• Bounced checks and overdrafts
• Unpaid negative balances
• Account, card, or ATM abuse
• Suspected fraud or identity theft
• Number of accounts applied for recently

How to Avoid Over-drafting 

We know that overdraft fees can be very frustrating. Here are some things you can do to reduce the risk of being hit with an overdraft fee in the future.

• Keep a close watch on your checking account balance. If you do not know how to balance your checkbook, various online resources are available to you, such as Quicken. Many consumers still use a checking register to balance their checkbooks the old-fashioned way. Either option is highly effective if you stay on top of it.
• Pay with cash when you can, especially for your wants. According to the 50/20/30 rule, 50% is applied to your needs, 30% to your wants, and 20% to your savings. So, consider getting cash to cover some of your wants so that you can prevent fees altogether.
• Set up alerts for low balances if your bank offers the feature. You may be able to receive an automated text, email, or phone call if your balance falls below a certain threshold.
• Link your checking account to your savings account so that if you do not have sufficient funds in your checking account, it draws funds from the secondary account.
• Get a prepaid debit card that you can use to help pay for your wants. This is a great way to prevent overspending too.
• Sign up for direct deposit from your employer. When you have direct deposit, your paycheck funds are available immediately. You don’t have to find time to get to the bank or wait for the check to clear.
• Use a perks credit card to make payments. This option is a great way to help you build or improve your credit score, provided you can keep your balance below 30%. If you try this option, ensure you are paying the full the sum of your purchases and expenses from the previous month. Otherwise, you could have a new problem on your hands - credit card balances that have gotten out of control.

With some careful budgeting, you will be able to significantly reduce your risk of incurring overdraft fees.

Know Your Balance and Your Budget

Keeping tabs on your financial situation is just one of those things that consumers need to do. One of the most important things you can do is keep track of how much money you have in your checking account. But not only should you know your current balance, but you need to have a note in your head to remind you of checks written or debit card purchases made against that balance, that are not yet reflected. 

One of the best things you can do is establish a budget to help you avoid overspending. Earlier, we mentioned the 50/20/30 method. Here is how it works:

• 50% of your take-home pay should be set aside for your needs. This includes your mortgage or rent payment, auto loan, student loan obligations, groceries, etc.
• 20% of your take-home pay should be applied to your savings. So, you can either move this money directly into your checking account or send it to your investment firm to add to your 401(k), a Roth IRA, or other plan. However, you should also earmark part of this fund for emergency expenses. We recommend that you strive for a balance of six months of your net pay in your savings account at all times.
• 30% of your take-home pay can be applied to your wants, such as that new pair of designer jeans, a family vacation, etc. Taking this money as cash each pay period and using that cash towards your wants can help keep you from overspending, keep your credit card balances from climbing, and help ensure you have enough money to prevent an overdraft on your checking account.

Keep Track of Automatic Payments 

Automatic payments are a great way to ensure you don’t miss a payment on an important bill. For example, if you miss the monthly payment on your credit card bill and don’t make it up within 30 days, your credit score could take a plunge of up to 180 points. Automatic payments are a great way to set-it-and-forget-it - almost. 

If you decide to explore this option, ensure you know when those automatic payments will hit your account. For many lenders and mortgage companies, you can request auto-pay to hit on the first or fifteenth of the month. So, be careful to ensure that you have sufficient funds in your account when those autopays are due. Autopays can help ensure you make your payments towards your personal loan for excellent credit on time every month, helping you to maintain that great credit score. But those automatic payments can set you up for failure when you aren't paying attention.

Set Up Account Alerts

Account alerts are a helpful feature many banks offer. You may be able to receive important information about balances, transfers, payments, and other transactions, directly as a text or email. If you receive an alert that your account is getting low, consider what is scheduled for autopay in the coming days and if you have written other checks that have not yet posted. If necessary, transfer money from another account to ensure an adequate balance. And if you can delay purchases until you can deposit more money into your account, all the better.

Sign Up for Overdraft Protection 

There are a lot of mixed feelings out there about overdraft protection. You should know that, ultimately, your bank decides when they will cover or reject a transaction that will put your account into the negative. If you opt out of overdraft protection, your bank cannot cover one-time debit card or ATM transactions or charge overdraft fees. They can cover checks and recurring debit transactions without asking for your permission. Some people don’t want to give their bank that kind of control.

However, if you live paycheck to paycheck and need to transfer money between accounts frequently. Overdraft protection can protect your account, keeping you from fee assessments until you can deposit more money. Think of it this way - if you have $1,000 in your checking account and $2,000 in your linked savings account or special overdraft account. You have a rent payment of $1,100 that comes due and is paid via overpaid; the bank could transfer money from the linked account to cover the remaining portion of the payment. Without this coverage, your payment wouldn’t clear and you would likely be assessed an insufficient funds fee from your bank.

Before signing up for the service, be sure you understand what fees come with the program. And, find out if you can link an existing account or need to keep funds in an alternate account. Sometimes, your overdraft account may work as a credit account, so be prepared.

Use Cash

Many people rely on debit and credit card purchases today versus using cash. But using cash whenever you can has many benefits. Paying with cash versus credit can help you achieve the following:

• It ensures your privacy
• It’s empowering when you take better control of your expenses and financial situation
• It’s fast
• It’s secure

People with regular access to cash, such as those in the hospitality industry who work for tips, can opt to spend their cash for their wants instead of relying on the money in their checking account.

Alternatives to Overdrafting

No one wants to intentionally overdraft on their checking account and pay the resulting fees. Here is what you can do instead.

• Stay on top of your balance
• Use your credit card so that you can summarize expenses at the end of the month and pay-off all at once - if you don’t have a traditional credit card, a secured credit card is a great way for you to build and improve your credit
• Apply for a personal loan to cover immediate needs or larger purchases
• Build an emergency fund to help you avoid overdrafting in the future
• Consider your income and if you need to take on a second job or pursue a side hustle 

What Does Affect Your Credit Score

Your credit score is primarily impacted by the following.

• Revolving credit such as your credit cards, home equity lines of credit, and personal lines of credit
• Open credit such as your home equity line of credit and debit cards that let you access credit repeatedly up to a specific maximum limit
• Installment credit such as mortgages, auto loans, student loans, and personal loans

Your payment history and management of these various types of credit is reported to the credit bureaus every 30 to 45 days. How well you manage these accounts will directly influence your credit score.

The FICO credit score range spans from 300 to 850 and the following factors are considered when calculating your score.

• Payment history: 35%
• Amounts owed: 30%
• Length of credit history: 15%
• Credit mix: 10%
• New credit: 10%

So, if you fail to make a payment on time and you don’t make good on it within 30 days, the lender will likely report your poor payment activity to the credit bureaus. This single factor can ding your credit score by as much as 180 points.

Rebuilding Credit After Overdrafting

As we have said, over-drafting on your checking account does not directly impact your credit score. However, if you are over-drafting regularly, it can indicate that you have entered some challenging financial times. To avoid over-drafting and the resulting damage to your credit score if you overdraft on a credit card or personal loan payment, do the following.

• Pay your bill on time every month
• Apply for a secured credit card or credit builder loan
• Become an authorized user on someone else’s credit card
• Consider credit counseling
• Get a side hustle to make a bit of extra income every month
• Reassess your expenses and scale back as needed

Overdrafting regularly is an indicator that you might be in financial distress. If this has happened to you, be sure to look at your financial situation carefully to determine what changes you need to make. And, in extreme situations, consider credit counseling. You can access a list of qualified credit counselors from the CFPB.

Final Word

Managing your expenses takes diligence and perseverance. And while overdrafting does not have an immediate, direct impact on your credit score, it can begin a trickle-down effect that causes other issues, which can cause the score to plummet. If you do overdraft, make sure you pay the fee quickly, preferably in less than five days. This will help you avoid your account being sent to a collections agency. All in all, taking steps to avoid an overdraft will save you money and help protect your overall financial health.