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At some point, everyone will experience an overdraft, regardless of whether you have overdraft protection or not. It is perfectly normal to experience cash flow problems from time to time, so long as it is a temporary issue, not an ongoing one. Given the commonness of bank overdrafts, it is important to understand the impact they could have on your credit score and financial health.
What is Overdraft Protection?
Usually, with a checking account, you’re only allowed to spend the money that is in that account. If you spend more money than what is in the checking account, this is known as an overdraft.
Overdraft protection is a service offered by banks which makes up the money from the overdraft by drawing from savings, a credit card, or another eligible account. Without overdraft protection, your purchase would be declined and both you and the vendor would be charged a non-sufficient funds fee. Overdraft protection services are not automatically applied to your checking account, your bank must ask if you want to use the service or not.
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What Happens When You Overdraft Your Bank Account?
If you opted to use the overdraft protection services your bank offers, there will be applicable fees. The fees are in place because the bank arranged a portion of the transaction on your behalf. The fee may be a one time charge or it could be a daily charge effective until your balance is no longer negative. If you’re unsure of what the fees are, inquire at your bank about overdraft protection pricing.
If you do not have overdraft protection services for your account, you won’t incur the applicable bank fees. Instead, the purchase you’re trying to make would be declined. You likely will incur a non-sufficient funds fee as a result of the declined transaction as well.
What About Non-Sufficient Funds?
Non-sufficient funds charges, NSF for short, are fees arising from a cheque you issued that couldn’t be cashed due to insufficient funds in your bank account. Since cheques aren’t as popular as they used to be, an NSF can also happen 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. Usually, the fee is withdrawn straight from your bank account and the withdrawal could result in an overdraft fee too. The fee for an NSF cheque can be quite hefty, generally around $40.
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Will An Overdraft Affect My Credit Score?
The short answer is no, an overdraft will not affect your credit score. 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 score won’t be impacted.
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Overdrafts can have an indirect relation to a poor credit score. If you commonly experience bank overdrafts, this is an indicator that you’re spending more than you can afford. Usually, people who overspend have poor credit score ranges because they frequently miss credit card payments, loan payments, or other similar payments. Once an individual starts missing payments frequently, it will be reflected in their credit report since payment history is a big contributing factor to the calculation of credit scores.
Even though an overdraft alone won’t impact your credit score, there are instances where it will have an impact on your credit score. An overdraft can overlap with other factors that will affect your credit score, these scenarios are discussed below.
Unpaid Bank Draft Fees
If you fail to pay your bank overdraft fees and bring your bank account balance up to $0 or greater, your bank could send the owed amount to a collection agency. Because this is a debt that is sent into collections, it would appear on your credit report and stay there for seven years, even if you pay it.
It is possible to negotiate with collection agencies to remove the item from your credit report once you’ve paid it, but there is no guarantee, some agencies are more strict than others.
Did a collections account disappear from your credit account? Read this to know why.
Using Credit Cards and Lines of Credit for Overdraft Protection
If you have overdraft protection that is linked to a credit card, an overdraft could have an impact on your credit score if it is considered to be a cash advance. Whether or not an overdraft withdrawal from a credit card is considered to be a cash advance depends entirely on the credit card issuer.
By using a line of credit for overdraft protection, you risk incurring fees on the overdraft if you don’t pay the balance before the grace period ends. Some lines of credit don’t have a grace period at all.
With both a credit card and line of credit, you may have to pay an overdraft fee if you don’t have enough available credit to cover the cost.
An NSF cheque is unlikely to impact your credit score 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 would negatively affect your credit score.
Credit Card Payment NSF Cheques
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 will be considered delinquent and reported to the credit bureaux. You also still owe the balance of your credit card which could be sent into collections too. Delinquent accounts do have a negative impact on your credit score.
Want to know if paying a collections account improve your credit score? Find out here.
To avoid penalties as much as possible, communicate with creditors. They may even waive NSF fees and give you additional time to pay. Note that this only applies when you write a cheque to pay your credit card, this is not applicable for all NSF fees in general.
What Does Your Overdraft Say About Your Finances?
If you commonly incur overdrafts, it may be an indicator of poor financial health. Bank overdraft protection services are designed to help people cover their expenses in special circumstances. Every now and then, finances get tight and that’s okay. But if you’re using overdraft protection services all the time, you are likely spending more than you can afford on a regular basis.
If you are using bank overdraft protection services frequently, there are ways to break the cycle and prevent a downward spiral into debt. The best thing you can do is keep track of your finances by budgeting and frequently reviewing your bank balances. This way you can ensure you have money in your account when you know a withdrawal will be occurring soon. Sometimes people incur overdrafts often because of a serious financial issue that is being ignored. If this is you, consider seeking professional help to get out of debt.
It is important to handle issues with frequent overdrafts sooner rather than later. Your current financial decisions could be impacting your financial health in the future. By getting your finances on track today, you will have better finances tomorrow.
Need to break your debt cycle? Why not consider credit counselling?
Getting Over Using Overdrafts
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, Loans Canada can give you the professional help you need today.
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