Do you have overdrafts? If so and you’re wondering if you can be denied a mortgage due to those overdrafts, I have good news. The answer is no!
While the lender is most certainly going to look into those overdrafts, this is not the kiss of death. The lender needs to understand why those overdrafts happened. They’ll take them into consideration along with the rest of your mortgage application.
It is extremely rare for a bank account overdraft to cause a mortgage application to be denied for a qualified applicant, so you can breathe a sigh of relief.
Hopefully, the rest of your qualifications are in good standing but an overdraft with the bank will generally not be the reason your application is denied.
Before you apply for a mortgage, read up on the following information so you can get the approval you’re looking for and buy the home of your dreams!
Authorized Overdrafts or Bank Overdraft Protection and Mortgage Applications
First, let’s talk about authorized overdrafts. Those are the kind you arrange with the bank in advance. You set a borrowing limit with your bank and are then able to spend that borrowed money up to said limit with your normal payment methods. You usually have fees associated with these types of overdrafts.
When you’re going through the application process with your lender, you’ll be asked to show some typical things like proof of income. You’ll also usually (though not always) be asked to show your last three bank statements that encompass the last several months). In the cause of authorized overdrafts, many lenders won’t hold it against you and it shouldn’t have any impact on your mortgage application.
That is, unless you regularly go over that overdraft limit. Then the lender might be hesitant to approve your application because you’re showing a trend of not fulfilling your existing financial commitments each month. If this is your situation, you should start to get a budget together and focus on a financial plan so that you are an appealing applicant. Some lenders will certainly be concerned if you seem to use these authorized overdrafts regularly to make your payments, but others will look at the bigger picture and see how you’re doing financially in other areas.
If you are maintaining those monthly commitments and not increasing your overdraft, you can breathe a sigh of relief though. That bigger picture really does come into play when lenders are reviewing your application. And if it’s an occasional overdraft, then you have even less to fret over, particularly when it’s conducted within the bank’s limits. Most lenders will overlook that when considering your mortgage application.
Need more peace of mind? You can also choose overdraft protection. These are basically lines of credit and any lines of credit come up on your credit report. So, when you have overdraft protection to secure up to $10,000, you could have a credit line for the same amount. Mortgage lenders will always look at the lines of credit you have. When you have used too much of it, that’s when it might have the potential to harm your mortgage application. This indicates you’re likely spread too thin and a bit risky to approve for mortgage payments.
Can I apply for authorized overdraft shortly before a mortgage application?
When applying for any type of credit, you probably are well aware a credit check is going to be run on you. Any time you have your credit run, it temporarily knocks your credit score down a little. So, if you just bought a brand new car and are financing it or you’ve applied for more credit cards, you might run the risk of being turned down.
It’s for this exact reason that I strongly advise that if you want to buy a house or an investment property and get a mortgage, you do not apply for any other financial products unless absolutely necessary. If you constantly fall into that red zone, you might find it’s best to apply for an authorized overdraft though. Because if you do just prior to putting in your mortgage application, it could make a big impact on how your creditworthiness is perceived by the lender.
Unauthorized overdrafts and their effect on mortgage applications
So, before I talked about authorized overdrafts and how they don’t always mean a negative impact for you when it comes to applying for a mortgage unless you’re constantly in that uncertain zone. But what about unauthorized overdrafts?
Sometimes these are called ‘unplanned’ or even ‘unarranged.’ This has happened to most people at least once in their lives. Perhaps you forgot your paycheck hadn’t yet cleared when you made a payment and there wasn’t enough in your account balance to cover the amount. This kind of overdraft also happens when you’ve had an authorized overdraft gone bad – when you go over the limit you’ve agreed to with the bank. When either of these scenarios plays out, that means you’re paying extra charges and those can stack up fast.
It’s ideal to avoid something like this, but many people in early adulthood usually make this mistake once. If you have had an unauthorized overdraft and it’s your only one, and perhaps even if happened a while ago, the lender will absolutely overlook this, especially if you have everything else squeaky clean.
But if you have frequently gone over the limit, you probably have been inundated with a cycle of fees and penalties, not to mention a credit blemish. The more problems with overdrafts you have, the more likely it is that the lender will turn down your application, even if you were willing and able to pay any fees and get into the clear. This is usually a sign that you’re high-risk. They look for patterns, and if you consistently have a pattern that shows you can’t keep up with your monthly payments for your other obligations, it’s a fairly good sign you won’t be able to handle monthly mortgage payments.
This cycle can be very difficult to break. It can also bring you into the land of bad credit. A low credit score, default, or judgment could wind up plaguing your dreams of homeownership for years. You do have the option to work with mortgage advisers that work with bad credit mortgages though, but the best thing you can do is try to get your situation straight before applying for your mortgage and prove you can be counted on to make mortgage payments without fail to your lender.
It might sound disappointing, but if you keep reading, I’m going to tell you how to avoid this mess and get the mortgage you want.
How to Avoid Overdrafts and their Consequences
Believe it or not, overdrafts were created to help you out. See, let’s say you accidentally forgot you didn’t yet get your paycheck yet and then paid your phone bill. Instead of having that transaction declined, your bank covers that bill for you and tacks on a fee. While it is great protection, I urge you to pay more attention to your banking so you don’t make this kind of mistake again. Making it once, as I said before, is not a big deal. But when it happens often, it’s a huge red flag to lenders that you don’t want to be waving around.
If you had an overdraft like this, contact your bank and tell them you want to opt-out of overdraft coverage. If you accidentally try to spend more than you have, that transaction will be declined and you’ll need to use another method for payment or become delinquent on the bill you’re trying to pay.
You can (and should) ask about overdraft protection. This permits you to link to a secondary account. If you have a savings account, linking it to your checking account is a much smarter option. This way, if your checking balance is low because your paycheck hasn’t yet cleared or deposited, the money comes out of your savings and helps cover the purchase. There are no fees or hints of trouble on your account when using this method.
Don’t have savings? You should set it up immediately. Some days are rainier than others and you will be so thankful when you have even just a little something set aside to handle an emergency, I personally keep enough to cover 6 months worth of expenses in a high-yield savings account. But you should never buy STUFF with your panic fund, like that computer you wanted or worst buy gifts with it.
How to prepare for a mortgage if you have an overdraft
Now you really want to buy a house, and I get it. However, you should note that a single-family home is not an investment!
Yes, I said it. A house is not an asset because it doesn’t pay you every month. You might not have to pay a landlord but you’d still have to pay property taxes, insurance, upkeep, and maybe even a homeowners association fee (HOA).
If you absolutely must buy a home and don’t want to rent, you can buy a duplex, triplex or even better a fourplex using an FHA loan (FHA stands for Federal Housing Administration), which allows you to only pay down about 5%, live in one unit and rent out the others. It’s called house-hacking, granted you’d have to crunch the numbers to make it work but that’s a post for another day. An even smarter thing would be to pay down 20% to avoid the Private Mortgage Insurance (PMI); it’s about 1% of the purchase price, this type of insurance aims to protect the lender from you defaulting on a loan and can be avoided by paying down 20%.
So, if you’re thinking about applying for a mortgage right now to get out of your current renting situation or in the not-too-distant future, you really must budget properly starting immediately. You need to keep enough money in that account before you try to apply. One of the biggest things you’ll need to commit to here is not spending on frivolous things. That means cutting out your morning coffee routine at the local café or bringing lunch to work more often than buying it. Trim your expenses wherever you can and make sure you pay attention to maintaining those financial commitments. If you can’t or won’t lower your standards of living you could increase your income by working two jobs or taking up a side hustle. All your bills must be paid on time. Short of a natural disaster, there should be nothing preventing you from paying your obligations in full on a regular basis.
You should also be trying to reduce any overdrafts that you do have during that period before you apply for a mortgage. This would also show a potential lender that you have control of your finances and a healthy relationship with money which is always a plus. Whatever you do, don’t exceed the limits of your overdraft during this time. If for some reason something major comes up, you may need to wait longer to clean up this area and get in good standing.
Keep in mind that most of the lenders out there will want to take a look at the last three bank statements over the last three months. This three-month span should be in immaculate condition. You should also keep from increasing your overdraft facility. Make sure there is enough money in your bank account at all times to avoid going over the overdraft.
Should you be overdrawn, you should always handle all of your commitments. Get them taken care of immediately. Then, pay any banking fees and overdraft fees. You don’t want to let those fall by the wayside because the bank can then charge you even more fees and list it as a default. You know what that means, right? That’s a bad credit blemish left on your history, one that will make it much more challenging to get approved on a mortgage application.
Not only do unpaid fees make you look less desirable to mortgage lenders, but these can also form into a lawsuit. That lawsuit will most certainly appear on your credit score and then will be known to the lender. Above all, avoid going over your overdraft limit. If you go over, it will definitely delay getting the approval on that mortgage.
Remember, while having access to an overdraft isn’t a problem, especially if it’s been kept as a line of credit and you’re not using that limit, going over it is. Don’t break the terms of your overdraft and you’ll still be an appealing candidate for approval on a mortgage application.
Can I use an overdraft as a mortgage deposit?
Based on what I’ve just mentioned, you probably can answer this question now. No, you shouldn’t use an overdraft for your mortgage deposit. This is a terrible idea for a bunch of reasons.
For starters, overdrafts were not created to be used for short-term purposes. Your bank could easily pull out in the blink of an eye, leaving you out to dry. If you don’t have a proper deposit, an adviser can usually suggest other alternatives for you.
Another thing you might be thinking about is taking a loan out to use for your deposit. This also isn’t something I’d recommend because the lender is going to look at the repayments on that loan and decide how much they’ll lend you. It works against you because they’d lend you less than they would if you didn’t have a loan.
What’s the Impact of Overdrafts on Credit?
Should you have an overdrawn account, you should pay the fees asked of you and put your money right into your account to get it into immediate positive standing. Depending on the bank, you may be charged a daily fee if you don’t get your account out of the red within a certain amount of days. And, if you don’t pay that debt, the bank will likely send your account over to collections. Cue the annoying phone calls that you will be sure to receive from collections agencies.
You most definitely do not want this to happen. Delinquent accounts have a majorly negative impact on your credit score. You should have a credit score that is a minimum of 620 if you want to get a conventional loan. What affects your credit? The payment history on any of your accounts always has an impact. If you are consistently late or you have any delinquent accounts, it lowers your score.
Other things that lower your credit is how much you owe creditors and how long your accounts have been in standing. Even the types of credit lines you have make a difference. But not all of these are negative impacts all the time. For example, having a credit card you always pay the balance of in full every month, or you have an auto loan and pay that on time, these things can weigh in your favor.
Keep reading, and I’ll tell you more about how mortgage lenders use your credit score to determine if you’re going to get approved or not.
How do mortgage lenders use your credit score?
Did you ever have that one friend that would always ask for money and swear they’d pay you back? You probably never saw that money again, did you? If you haven’t been reliable with borrowing money, you’re going to look just like that old mooching friend to creditors and lenders. The credit score you have is the barometer for how reliable you are when repaying debts. These things are measured from up to 7 years prior and can all play a role in your credit score.
As you’re applying for that mortgage, the lenders will take a look at your credit score first to make their initial assessment. They go through an external credit reference agency to check it out. There are three major credit reference agencies in the US: Equifax, TransUnion, and Experian. All three of these agencies use a unique algorithm to compute your credit score. Meanwhile, every lender out there has different boundaries in place as to what they deem acceptable or not. That’s why I want you to know something very important: one lender may not approve you for a mortgage while another one will.
If you think about it, it’s like credit cards. Sometimes you apply for one and get approved immediately. Other times, you’re turned down. Knowing what your scores are by these credit agencies and what lenders deem as acceptable will help your mortgage application process be more fruitful.
Tips for building your credit score
If your credit score is low across the board though, you’re going to have to build it up. Fortunately, I’ll tell you just how to do that so keep reading!
Don’t feel too badly about having an unauthorized overdraft. You can still turn things around and fix your credit score. It won’t happen overnight, but if you keep at it, things will soon go your way.
– Pay those debt repayments on time
When you pay off any of your current debts and do so on time, your credit score increases. It shows you are a reliable buyer, one who can be trusted to make good on a debt (unlike that old friend…where is he now anyway?). Credit cards are a great way to do this. If you pay your entire debt on the card in full every month, you don’t pay any interest. You should give some thought to getting a credit card that’s designed for someone in a bad credit situation which can help you get things going in your favor.
– Pay for your utilities directly
You always have to pay your electricity bill, don’t you? Making the payment for your monthly bills, especially when you go directly through your debit account can boost your credit score. You need to be careful though because missing a payment could make things even worse. The ideal solution is to set up an auto-pay feature. This ensures you’re never late and you never miss a payment.
– Avoid applying for too many credit cards
Building credit through a credit card is a great idea. A bad idea though is opening up a bunch of credit cards. Don’t be lured in by stores trying to hook you with 5% off or other incentives just to get another card. Every time you apply for a credit card, it lowers your credit score. If you have only a few cards and are responsible with them by paying the balance by the due date in full every month, then it’s not a problem. But if you start waving your cards around, forgetting that you actually have to pay for what you buy in the long-run, it could worsen your debt situation.
Ideally, you should apply for a good credit card well before you apply for a mortgage. Build up your credit and turn your credit score into the kind of number lenders want to see. Then go ahead and apply for that mortgage.
– Correct your credit report
For some of you though, you might have blemishes on your credit report that you are not aware of. This is why it’s so important to check on your credit long before you apply for a mortgage. That mooching friend could have used your name to apply for a card or an error could have been made by one of your creditors. Check first to see if anything is out of the ordinary. It’s free to do by getting in touch with the three credit agencies and requesting a report.
And the one thing you should NEVER do…
DON’T get an unauthorized overdraft. Again, if you had one once ages ago, it’s likely nothing to worry about, especially if the rest of your financial matters are in order. But if it’s happened recently or it’s happened frequently, most lenders will file you into the ‘unreliable’ file.
Bottom line
By taking care of your credit before applying and correcting any problems with overdrafts and credit scores, you significantly increase your chances for being approved on a mortgage. Follow my steps above for getting your credit in good standing and you’ll should soon find you’re stamped with an approval on your mortgage application.
Don’t forget that if you’re on the cusp, different lenders may say ‘no’ or ‘yes,’ but the more you do to solidify your standing as someone who’s responsible with paying back debt, the more quickly you should get what you want.
