Even though credit cards are one of the most common ways of making transactions, not many people understand the mechanism through which they work. That’s why credit cardholders can, unfortunately, make bad financial decisions that can ultimately lead to being stuck in tricky financial situations. One such financial problem that can arise, and one that many people aren’t aware of, is that of an overdraft.
Here is more information about overdrafts and how you can help maintain a good credit score.
What Are Overdrafts?
To put it simply, an overdraft is when a bank allows its customers to borrow a set amount of money. This happens when a bank allows you to withdraw money from your account, even if your account doesn’t have enough money to cover the transaction. An example of an overdraft would be when you spend $800 while only having $500 in your bank account. You will write a check for $800 to the retailer to make the payment. However, you’re $300 short of the amount. In this case, your bank can let the check bounce and let the retailer know about your insufficient funds. Or the bank could process the check and allow you to make the purchase, which means you have an overdraft of $300. So technically, an overdraft is a situation where your account balance is negative. In most cases, overdrafts are supposed to be returned with an interest fee designated by the bank. However, these costs can spiral out of control if overdrafts aren’t handled properly and responsibly.
Overdrafts and Credit Scores
Overdrafts can hurt your bank balance, but does an overdraft affect your credit score? The simple answer is that it depends on how you deal with an overdraft. Overdrafts are not likely to have a major impact on your credit score as long as you don’t go beyond your overdraft limits or have your payments refused. In fact, overdrafts can even positively affect your credit rating if you pay them on time. They can also help you when it comes to borrowing money, as a timely paid overdraft shows you’re a responsible borrower. However, if you regularly go beyond your overdraft limit, it can seriously damage your credit rating and make it difficult for you to borrow loans. This is because lower credit scores can show lenders that you’re a risky borrower.
Credit Reports and Checking Accounts
Your credit report does not contain your bank account information. As a result, your account status cannot impact your credit scores. However, lenders ensure you have the capacity to take on more debt by checking your assets and savings. Lenders also look at your payment history details, credit scores and credit report to see your closed and open credit accounts and loans.
Overdraft protection is a tool that banks use to save their customers from embarrassment in insufficient funds. This system works by linking your checking account to your savings account, another checking account or a line of credit. This allows your secondary source of money to get tapped for funds if there are any financial shortfalls with your primary checking account.
However, banks can also charge a fee for overdraft protection. It’s best to contact your bank to learn about the overdraft protection they offer.
How To Help Maintain a Good Credit Score
You can help maintain a good credit score by following the advice given below:
- Monitor your credit and limit your spending
- Check your eligibility for every new loan you borrow
- Take only one loan at a time.