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How an overdraft affect your mortgage application

An overdraft can affect your application if it's sent to collections.

An overdraft can occur when you try to spend more money than is available in your checking account. If the transaction goes through and your account goes into the negative, you are responsible for repaying your financial institution the overdraft amount plus any applicable fees. If you bring your account back into good standing, you don’t have to worry about it negatively affecting your mortgage application, as checking accounts aren’t reported to credit bureaus.

However, if you fail to repay the overdraft amount and any fees, your financial institution can send your debt to collections. A collection account may be reported to any or all three of the major credit bureaus – Equifax, Experian and TransUnion – and reflected on your credit reports.

A collection account can remain on your credit report for up to seven years and will likely have a negative impact on your credit score. In this instance, an overdraft can affect your mortgage application. But that doesn’t necessarily mean you won’t qualify for a mortgage.

How do mortgage lenders use your credit score?

Your credit score is an indicator of how reliable you’ve been when borrowing money. Negative information such as late payments, collection accounts and bankruptcy records can stay on your credit report for seven to 10 years, depending on the type of information, and can also hurt your score.

When you apply for a mortgage, lenders will check your credit report and score as part of their assessment of your creditworthiness. Lenders may pull one, two or all three credit reports in making their decision, so there’s a good chance they’ll see any accounts you have in collections.

How do mortgage lenders perceive overdraft usage?

Upon viewing your credit report, a lender will likely only be able to tell that you have an account in collections and not that it’s a result of having an overdraft on your checking account. Even so, having an account in collections may not disqualify you from obtaining a mortgage.

Lenders consider a range of factors when making their decision. However, you may be asked to provide a letter explaining the reason your account went to collections.

According to HUD, VA and Fannie Mae/Freddie Mac guidelines, outstanding collection accounts don’t have to be paid off as a condition for approval. So, in general, the impact your collections account has on your mortgage application will depend on the type of loan you’re applying for.

Tips for building your credit score

If you’ve had an unpaid overdraft sent to collections and it’s hurt your credit score, all is not lost. Here are a few things you can do to repair your credit score so you have the best shot at being approved for a mortgage:

  • Make debt repayments on time. Payment history makes up about 35% of your total credit score, so it’s typically the most important factor in determining your score. Lenders want to see that you are a responsible borrower and demonstrating that you repay your debts on time is the best way to show that. Credit cards are useful tools for quickly building positive payment history with proper use. If you have poor credit and can’t qualify for an unsecured credit card, there are numerous secured credit cards that can help you rebuild your credit.
  • Reduce spending to pay down debts faster. Credit utilization — that is, the amount of total available credit you’re using — is another important factor in determining your credit score, making up about 30% of your total score. If you can hit pause on any frivolous spending and find ways to cut back to free up some additional money to throw at your debts, you’ll find that your credit score will benefit.
  • Pay utilities and other bills using Autopay. Late and missed payments will stay on your credit report for up to seven years, so it’s important to always make your payments on time. Autopay allows you to automate bill payments so you’ll make your payments on time every month. But make sure your account has enough cash to avoid an overdraft.
  • Don’t apply for too many financial products. Every time you apply for credit, the lender will run a hard credit check on you. This inquiry not only stays on your report for a couple of years but also produces a short-term hit on your credit score, so it’s best to refrain from applying for credit in the months leading up to a mortgage application.
  • Fix your credit report. Errors on your credit record are possible. They can have a detrimental effect on your credit score, so it’s worth checking for any mistakes and fixing them. Federal law allows you to get a free copy of your credit report once every 12 months from each major credit reporting agency.

It’s unlikely that an overdraft will negatively affect your mortgage application, but it’s not entirely out of the question. If you have an overdraft, repay it as soon as possible to avoid incurring any further fees and to get your checking account back into good standing so that it can avoid collections.

If you’ve had an overdraft sent to collections and are worried it’ll affect your ability to get a mortgage, call and speak to a loan officer directly to explain your situation. Lenders consider the entirety of your credit profile. An overdraft – even if it makes its way to your credit report – probably won’t completely derail your chances of getting a mortgage.

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