If you’re like many people in the UK, you might have an overdraft facility with your bank. It’s a handy tool for those unexpected expenses or end-of-the-month shortfalls.
But when it comes to applying for a mortgage, you might be wondering: does an overdraft affect a mortgage application?
This is a crucial question, especially if you’re considering stepping onto the property ladder or remortgaging your home. In this article, we will look at the impact of overdrafts on mortgage applications and provide some practical tips to help improve your chances.
Understanding overdrafts
Let’s first clarify what an overdraft is.
An overdraft is an unsecured borrowing facility that allows you to spend more money than you have in your bank account, up to a certain limit agreed with your bank.
Most overdrafts will be linked to a current account, or cheque account.
There are two types of overdrafts:
Authorised Overdraft
An authorised overdraft, also known as an arranged overdraft, is a borrowing facility agreed with your bank that allows you to spend more money than you have in your account, up to a fixed limit.
It acts as a short-term safety net for unexpected expenses or temporary cash flow problems. To get an authorised overdraft, you need to apply through your bank.
The bank will assess factors such as your income, credit history, and how you’ve managed your account in the past. If approved, you’ll be given a limit and will be able to automatically spend up to this amount when your account balance is zero.
Unauthorised Overdraft
An unauthorised overdraft, or unarranged overdraft, occurs when you spend more money than you have in your account without an agreed overdraft limit, or when you exceed your authorised overdraft limit.
Essentially, it’s borrowing from the bank without prior agreement. Using an unauthorised overdraft can happen quite easily, for instance, if a direct debit or standing order goes out of your account and there isn’t enough money to cover it.
However, it’s important to avoid using an unauthorised overdraft where possible, as it comes with high fees and charges, and will negatively impact your credit score.
How overdrafts can affect your mortgage application
When you apply for a mortgage, lenders look at various factors to assess your financial stability and ability to repay the loan. One of these factors is how you manage your bank account and whether or not you go overdrawn.
Here’s how it can influence your mortgage application:
Overdraft Usage
Lenders view the usage of your overdraft as an indicator of your financial management. Occasional use of an authorised overdraft, within the limit, is generally acceptable. However, if you’re frequently dipping into your overdraft or consistently hitting the limit, lenders might see this as a sign of financial stress. It won’t do you any favours for a lender to see your overdraft fully utilised for most of each month when they look through your bank statements.
Size of Overdraft
The size of your overdraft can also impact the lender’s opinion. A small/modest overdraft limit might not raise any eyebrows, but a large one could. If you have a large overdraft limit, lenders might worry that you could suddenly plunge into debt, increasing your financial commitments and potentially affecting your ability to repay the mortgage.
Unauthorised Overdrafts
Unauthorised overdrafts are a red flag for lenders. Regularly falling into an unauthorised overdraft suggests that you’re struggling to manage your finances, which could make lenders think twice about offering you a mortgage due to affordability concerns.
Affordability and debt-to-income
As well as looking in to your credit history, lenders have to assess your affordability for the new mortgage. This is how you can afford the mortgage payments each month. The lender will calculate a ratio; between your debts and your gross income. This is a debt-to-income ratio. As an overdraft is a debt, it will be included within this calculation and could, therefore, reduce the amount you can borrow.
Credit scores and overdrafts
Your credit score is a numerical representation of your creditworthiness, based on your history of managing credit and debt. Lenders use your credit score to help assess the risks involved in lending to you.
So, how do overdrafts fit into this picture?
Authorised Overdrafts: If you have an authorised overdraft and use it responsibly (or don’t use it at all), it’s unlikely to have a detrimental impact on your credit score. In fact, well-managed overdrafts can demonstrate to lenders that you’re capable of handling credit responsibly.
Unauthorised Overdrafts: On the other hand, unauthorised overdrafts are going to lower your credit score.
Remember that your credit report contains financial information over the last six years and is updated each month.
Each lender has their own criteria when it comes to assessing credit scores and overdrafts. Some might be more lenient, while others might have stricter rules. It’s always a good idea to get a copy of your credit report, check your credit score and understand your financial standing before applying for a mortgage.
Tips for managing overdrafts when applying for a mortgage
If you’re planning to apply for a mortgage and you have an overdraft, here are some tips to help you manage your situation:
- Stay within your limit: Try to avoid going into an unauthorised overdraft situation. Not only can this lead to penalty charges, but it can also harm your credit score and potentially affect your mortgage application.
- Reduce or cancel unused overdrafts: If you have an overdraft limit that you don’t use, consider reducing it or cancelling it altogether. Lenders may view unused overdrafts as potential debt, so reducing your limit could make your financial situation look more stable.
- Avoid making major changes: If you’re planning to apply for a mortgage in the near future, avoid making significant changes to your overdraft, such as increasing your limit. This could be seen as a sign of financial stress and could potentially affect your mortgage application.
Remember, every lender is different, and what one lender views as a problem, another might not. It’s always a good idea to speak to a mortgage broker or financial advisor to understand how your overdraft could affect your specific situation.
To give yourself the best chance of mortgage approval, you will need to plan a few months ahead of when you need to apply for a mortgage. This time should be spent reducing all unsecured debts; overdraft and credit cards and also making sure your current account is well managed. (and not too many Deliveroo entries on your bank statements!)
How a Mortgage Broker can help
An experienced independent mortgage broker can be an invaluable ally when you’re applying for a mortgage, especially if you are concerned about your overdraft. They have extensive knowledge of the mortgage market and understand how different lenders assess overdrafts.
Here’s how a broker can help:
Improving your situation: Your broker will be able to make some suggestions to increase the likelihood of a mortgage approval. Warning: Suggestions may include not going out as much, skipping the Costa Coffee routine and cutting back on other non-essential spending.
Matching you with the right lender: Brokers have a broad view of the mortgage market and can match you with lenders who are more likely to approve your application, despite your overdraft.
Navigating the application process: The mortgage application process can be complex and time-consuming. A broker can guide you through it, helping you avoid potential pitfalls and maximise your chances of approval.
While an overdraft will most likely impact your mortgage application, it doesn’t have to be in a negative way.
The key is to manage your overdraft responsibly and understand how lenders view it. Stay within your limit, maintain a good credit score, and seek professional mortgage dvice.
Remember, every person’s financial situation is unique, and what works for one person might not work for another.
Whether you’re a first-time buyer or looking to remortgage, understanding the impact of an overdraft on your mortgage application is crucial. So, keep these tips in mind, manage your finances responsibly, and you’ll be well on your way to securing your new mortgage.
