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It is perfectly normal to experience cash flow problems from time to time. In certain circumstances, you may even rely on a bank overdraft to cover expenses. While this can be a practical solution, especially if you have overdraft protection, there could be negative consequences if you don’t use it responsibly. Given that bank overdrafts are fairly common, it is important to understand the impact they could have on your credit scores and financial health.
What Is Overdraft Protection?
An overdraft occurs when there aren’t sufficient funds in your bank account when you make a transaction or withdrawal. Instead of your transaction being denied and incurring an NSF fee, overdraft protection will allow the transaction to pass and your account will have a negative balance, up to your overdraft limit. The negative balance in your account is your overdraft balance.
Bank overdrafts are basically a small temporary loan that you must pay back within a specific amount of time (varies by bank). Interest is usually charged on the amount overdrawn and there is usually a fee of $2.50 – $5 a month or for each overdraft transaction.
How Does Overdraft Protection Work?
Let’s say you have $100 in your bank account, and you make a transaction of $150. That would mean you’d be overdrawn by $50 and your account balance would show a negative balance of $50. This amount would have to be paid back along with interest and fees. To pay it back, you simply need to add money to your account. For example, if you deposit, $250, your account balance would display $200 minus the fees and interest.
Overdraft Protection Fees
If you opted to use the overdraft protection services your bank offers, there will be applicable fees. The fee may be a one-time charge or it could be a pay-per-use fee, which typically ranges between $2.50 to $5. If you’re unsure of what the fees are, inquire at your bank about overdraft protection pricing.
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What Are Non-Sufficient Funds (NSF)?
If you do not have overdraft protection services for your account, you won’t incur the applicable overdraft bank fees. Instead, the purchase you’re trying to make would be declined. You likely will incur a non-sufficient funds (NSF) fee which can cost upwards of $35.
When Can You Incur NSF Fees?
- From a cheque you issued that couldn’t be cashed due to insufficient funds in your bank account.
- When a creditor tries to make an automatic debit on your account and there are insufficient funds. Many people refer to this as a bounced cheque in addition to an NSF.
Will An Overdraft Affect My Credit Scores?
The short answer is no, an overdraft will not affect your credit scores. Your banking information is not regularly sent to the credit bureaus because it is your money, not borrowed money. So long as you bring your balance back to $0 or greater and pay the overdraft bank fees in a timely manner, your credit scores won’t be impacted.
Can An Overdraft Affect Your Credit Scores If You Don’t Pay It Back?
If you do not pay back your overdraft balance, your bank has the right to close your bank account and send the amount owing to a collection agency. If this happens, it could negatively impact your credit scores as it would appear on your credit report and stay there for seven years, even if you pay it.
Can Overdraft Protection On Credit Cards and Lines of Credit Affect Credit?
If you have overdraft protection that is linked to a credit card or line of credit, your bank will use the funds from there to cover your transactions when your bank account has insufficient funds.
- Line Of Credit – With a line of credit, you’ll owe interest on the amount you’ve overdrawn. If you fail to make your minimum payments on your line of credit, it could impact your credit scores. Moreover, by adding your overdrawn balance to your line of credit, you’ll be increasing your debt-to-credit ratio which may also affect your credit scores.
- Credit Card – With a credit card, your bank will cover your overdrawn amount with a credit card cash advance. This means the cash advance interest rates will apply on the amount overdrawn using your credit card. Similar to a line of credit, your credit scores may be affected if you fail to pay back your cash advance.
Could NSF Payees Affect Your Credit?
An NSF cheque is unlikely to impact your credit scores so long as you handle the situation in a reasonable amount of time. However, the person or entity you were trying to pay with that cheque is still looking for their money. Since they haven’t been paid, they have the right and authority to send your account into collections which could negatively affect your credit scores.
Could Credit Card Payment NSF Cheques Affect Your Credit?
If you issue a cheque to pay your credit card and it bounces, you will be charged an NSF fee. If you don’t pay the NSF fee within 30 days, your account may be considered delinquent and reported to the credit bureaus. You also still owe the balance of your credit card which could be sent into collections too. Delinquent accounts can have a negative impact on your credit scores.
How to avoid NSF fees?
How do I avoid using overdraft protection?
What is overdraft protection for?
Relying on overdraft protection services is not a healthy method of handling your finances. Ensuring you can comfortably afford your debt and lifestyle is a major key to financial success. If you’re experiencing problems with overdrafts or debt issues, consult a credit counsellor to help you get out of debt.
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