How Overdraft Loans Can Improve Your Credit Score – Explained

Let's say you run a small business and suddenly have the chance to buy stock at a low rate. 

But there's one issue: your account balance is low. 

What do you do? This is where an overdraft loan can help. It lets you use more money than what's in your account, up to a limit. You only pay interest on the amount you use, not the full limit. That means it's flexible and valuable in a pinch.

The good part is that using the overdraft smartly and repaying it on time can increase your credit score. Timely repayments show lenders that you are responsible for money.

According to RBI data, personal loans, which hold a major share 31.5% of total credit, recorded a moderation in annual growth to 13.7% in December 2024.

Overdrafts are quick cash solutions and can support your financial health if used correctly.

What Is an Overdraft Loan?

An overdraft loan lets you withdraw more money than your account balance, up to a set limit approved by your bank. 

For example, if you have ₹3,000 in your account and your overdraft limit is ₹10,000, you can spend up to ₹13,000. 

Interest is charged only on what you use, not the full ₹10,000. It’s like a credit buffer. This loan doesn’t need paperwork every time you use it, and you can repay it as you please, though interest keeps adding up till you repay.

Difference Between Authorised and Unauthorised Overdrafts

Understanding the type of overdraft is important because it decides how much interest you’ll pay and whether it affects your credit score. 

Here’s a comparison to make it simple:

Let’s say Rahul has an authorised overdraft of ₹20,000. He uses ₹5,000 to pay a sudden electricity bill and repays it in a week. He pays only for 7 days of interest. 

But Priya, who had no arrangement, spent ₹2,000 extra during a weekend shopping trip. Her bank charged her ₹500 in penalties plus high interest.

How Overdraft Limits Work?

Your overdraft limit depends on your income, bank balance history, account type, and relationship with the bank. Salaried people usually get limits between ₹10,000 to ₹2,00,000. Business accounts can get higher limits.

For example, if you earn ₹50,000 monthly and maintain good savings, the bank might offer you a ₹75,000 overdraft. But you don’t have to use the full amount. If you borrow ₹15,000 to fix your scooter and repay it in 20 days, you’ll only pay interest on ₹15,000 for those 20 days.

Banks review limits yearly. If you use and repay well, they may increase your limit.

Does an Overdraft Loan Affect Your Credit Score?

Overdraft loans are not credit cards; they still show your bank and other lenders how you manage money. Responsible use can 

improve your financial image, while bad use can hurt your score. Here’s how it works:

When Overdraft Activity Gets Reported to Credit Bureaus?

If you use and repay your overdraft responsibly, it may not even show on your credit report. But if you miss payments or delay too long, banks may treat the amount like a loan default and report it to credit bureaus like CIBIL or Experian. That’s when your score may go down.

Example: If you owe ₹12,000 in overdraft and don’t repay for over 90 days, the bank might mark it as NPA (non-performing asset), just like a bad loan.

Impact of Consistently Using vs. Maxing Out the Overdraft

Some people think using overdraft regularly will boost credit history. That’s partly true, but only if used wisely. Here’s how it affects your score:

Let’s say Suman uses ₹10,000 from her ₹1,00,000 limit and repays in a week. Banks see her as responsible. But her cousin Arjun always uses the full ₹1,00,000, pays late, and sometimes even crosses the limit. His CIBIL score dropped from 740 to 660 in 6 months.

How Repayment Behaviour Is Tracked?

Banks track how often and how fast you repay the borrowed amount. Repaying quickly, within days or weeks, shows good behaviour. Some banks even reward this by offering higher limits or lower interest.

If you leave your overdraft unpaid for months, it adds to your financial stress. Let’s say you borrowed ₹25,000 and didn’t repay for 2 months. You’ll pay interest plus fees; the bank might mark you as high-risk. This affects your chance of getting future loans, even for a home or car.

Positive Ways an Overdraft Loan Can Boost Credit Score

• Establishing Credit History for New Users

If you’re just starting out, maybe you just got your first job, you might not have a credit score yet. Banks often hesitate to offer credit cards or big loans to new users with no credit history. A small overdraft facility of ₹10,000 to ₹50,000 is easier to get and can help you start building your credit profile.

For example, Meena, a recent graduate in Pune, got a ₹15,000 overdraft from her salary account. She used ₹3,000 to pay for a work course and repaid it in 10 days. This small activity helped her credit file get created and showed timely repayment.

• Showing Responsible Credit Use

When you use an overdraft wisely and repay it quickly, you show that you can handle credit. Lenders check this before giving out bigger loans.

Let’s see how different user behaviours appear to banks:

This behaviour helps banks decide how much more credit you can manage later. Responsible overdraft use can lead to higher loan approvals or better interest rates.

• Supporting a Better Credit Utilisation Ratio
  
  

Your credit utilisation ratio means how much credit you use compared to how much is available. Lower is better. So, if your limit is ₹1,00,000 and you only use ₹20,000, it shows you're not dependent on credit. Overdrafts increase your total available credit, which can improve this ratio.

Here’s a quick example:

Ravi had a credit card limit of ₹50,000 and used up ₹40,000. His credit ratio was 80%. After getting a ₹50,000 overdraft (and not using it much), his ratio dropped to 40%, helping his CIBIL score go up slowly over time.

• Proving Timely Repayments Improve Creditworthiness
   

Credit scores increase when you show you can repay credit on time. Even small amounts repaid quickly add up to a strong repayment history. Banks track if you repay your overdraft within a few days or if you delay it.

For example, Neha used ₹8,000 from her ₹25,000 overdraft to book emergency train tickets. She repaid it after 4 days. She did this 3 times in 6 months. Her bank marked her as a low-risk customer and even offered her a ₹2,00,000 personal loan later at a better rate.

Over time, these small actions build your reputation as a trustworthy borrower.

Best Practices for Using Overdraft to Improve Credit

• Keep Usage Below the Limit

Always try to use less than 30–40% of your overdraft limit. Using the full amount often makes you look credit-hungry. It also increases interest costs. Banks also see this as a red flag.

Example: If your overdraft limit is ₹50,000, try not to use more than ₹15,000 unless really urgent. This shows control and planning.

• Repay Quickly and Regularly

The faster you repay, the less interest you pay, and the better it looks to the bank. Aim to repay within 7–15 days if possible. You don’t have to wait for your salary to clear the dues. Use any extra income to repay the overdraft first.

Mitesh, a graphic designer in Ahmedabad, repaid his ₹12,000 overdraft in just 5 days using freelance income. His bank increased his overdraft limit from ₹20,000 to ₹40,000 in six months because of his repayment speed.

Avoid Dipping Into Unauthorised Overdraft

• Never cross your approved limit.
• Doing so not only brings penalty charges but also affects your credit record if left unpaid.
• Unauthorised overdrafts can also damage your relationship with your bank.
• Let’s say you have a limit of ₹1,00,000 but spend ₹1,05,000.
• The extra ₹5,000 is unauthorised, and the bank may charge you ₹500 or more instantly.

Track Usage and Set Alerts

• Keep an eye on your overdraft use just like you track your mobile data.
• Most banks let you set SMS or app alerts.
• This way, you know when you’ve used part of the limit and when it’s time to repay.
• Setting a reminder every Friday to check and repay any overdraft helps build a repayment habit.
• It also saves you from surprise interest charges.

Conclusion

Overdraft loans are more than just emergency cash, they are also a powerful tool to improve your credit score. 

Uf you're just starting your financial journey or trying to rebuild your credit, using overdrafts smartly can help. Stay within your limit, repay quickly, and avoid unauthorised use. 

Over time, these small steps show banks that you're a responsible borrower. Just remember, overdraft is not free money, it’s borrowed money with interest. Use it wisely, and it can increase your financial reputation in the long run.

FAQs

1. Can an overdraft loan really improve my credit score?
Yes, if you use it wisely and repay on time, it can show good credit behaviour and improve your score.

2. Will an overdraft loan show on my credit report?
Not always. But if you delay repayments or default, it may get reported to credit bureaus.

3. How much overdraft should I use to stay safe?
Try to use less than 30–40% of your limit. This keeps your credit usage ratio healthy.

4. Is an overdraft loan better than a personal loan?
It depends on your need. Overdraft is better for short-term, small needs. Personal loans suit larger expenses.

5. Can students or new earners get overdrafts?
Yes, many banks offer small overdrafts (₹10,000–₹50,000) on salary accounts, even for new earners.

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LoansJagat Team

We are a team of writers, editors, and proofreaders with 15+ years of experience in the finance field. We are your personal finance gurus! But, we will explain everything in simplified language. Our aim is to make personal and business finance easier for you. While we help you upgrade your financial knowledge, why don't you read some of our blogs?