Does overdraft affect credit score?

Overdraft fees: something that can be a real headache when managing your finances. We get it, sometimes unexpected expenses come up, but overdraft fees can make a tough situation even tougher. What further complicates the situation is not having a proper understanding of how overdraft fees and overdraft protection works.

In fact, a report by the Financial Consumer Agency of Canada found that while most Canadians understand how overdraft fees work, many are not aware of the potential costs involved. That’s why it’s more critical than ever to understand what you’re getting into with overdrafts and how it may affect your credit score. Let's take a closer look at what you need to know to navigate this aspect of banking with confidence.

How overdraft works and how it can affect your credit score

Overdraft is a banking feature that allows you to withdraw more money from your account than you have available. Essentially, your bank is loaning you the extra funds, and you're expected to pay it back with interest.

Imagine you have $1000 in your bank account, and you make a purchase for $1500. This would result in your account being overdrawn by $500, meaning your balance would show a negative amount of -$500. If you don't repay this amount promptly, you may be charged overdraft fees and interest, which can add up quickly.

To repay the overdraft, you'll need to add money to your account. For instance, if you deposit $2500, your account balance would be $2000 minus any applicable fees and interest. The longer you take to repay the overdraft amount, the more interest and overdraft fees you'll accumulate—making it even more challenging to get out of debt.

If you overdraw your checking account without overdraft protection or write a check that bounces, it won't show up on your credit report immediately. That's because your checking account isn't typically listed on your credit report. However, things can quickly take a turn for the worse if you don't take care of the negative balance and overdraft fees. In that case, your bank may send your debt to a collection agency, and most of them do report to the credit bureaus.

Once the debt appears on your credit report, it can negatively impact your credit score. Therefore, it's important to keep an eye on your checking account balance and avoid overdrafts and bad checks whenever possible.

Overdraft protection fees:

How they work

If you've ever overdrawn your checking account, you know how quickly those overdraft fees can add up. That's why some banks offer overdraft protection, which automatically covers overdrafts by transferring funds from another account or line of credit. However, while overdraft protection can be a useful safety net, it often comes with its own fees. And those fees can add up quickly and affect your credit score.

When you sign up for overdraft protection, you'll typically be charged a fee each time your account is overdrawn and the service is used. The amount of the fee can vary depending on your bank, but it's usually around $35 per transaction. These fees can be accompanied by high-interest rates, which can make it even more challenging to repay the overdraft amount.

How overdraft protection may affect your credit score

Overdraft protection fees won’t directly impact your credit score—if, and only if, they are paid right away. Overdraft protection can indirectly affect your credit report in a number of ways if the fee is not paid within the stipulated time. For one, if you have a negative account balance for an extended period, your bank may close your account and send it to a collection agency, which can harm your credit score. Additionally, if you're unable to pay off your overdraft balance and fees, the unpaid debt may be reported to credit bureaus, which can significantly lower your credit score.

Another thing to keep in mind: Although banks may present overdraft protection service as a convenient perk, it's important to understand that overdraft protection essentially functions as a line of credit. This means that it can trigger a hard inquiry and appear on your credit report as a revolving account.

Every bank is different when it comes to reporting overdraft protection to credit bureaus. Before enrolling for this service, take the time to find out if and how your bank reports it. Being informed can help you avoid any surprises down the road and make sure that you are making the best financial decisions for your credit score.

How to protect yourself from the negative impacts of overdraft fees

It may sound straightforward, but the simplest way to protect yourself against overdraft fees and its impact on your credit score is to take measures to prevent overdrawing of funds in the first place. The first measure you can put in place is to keep a track of your account balance and spending. You can set up alerts with your bank to notify you when your balance is low, and consider using budgeting tools to stay on top of your expenses. Additionally, you may want to opt-out of overdraft protection—this means any transactions that may cause your checking account to be overdrawn will be declined by your bank.

What you can do if you’re charged an overdraft fee

We've all been there—you check your bank account and realize you've been charged an overdraft fee, which can feel like a gut punch. Fortunately, there are a couple of options you can exercise to get out of that jam.

For instance, you may be able to get the overdraft fee waived by taking prompt action and contacting your bank as soon as possible. Explain the situation to them and if you have a good track record of managing your account, they may be willing to waive the fee as a one-time courtesy. Additionally, you can ask your bank to opt you out of overdraft protection, which can prevent this from happening again.

However, if you're looking for a more long-term solution to avoid overdraft fees altogether, KOHO's overdraft protection cover may be a good option for you. KOHO's overdraft protection cover is a feature that allows you to spend beyond your account balance up to a certain limit without getting charged overdraft fees. When you sign up for KOHO, you'll be prompted to set up overdraft protection, which is available to all KOHO users. This means that if you try to spend more than what's in your account, KOHO will cover the difference, up to a limit of $100, without charging you any overdraft fees. Plus, with features like real-time spending notifications and budget tracking, KOHO can help you stay on top of your finances and avoid unnecessary fees.