If you are currently working to establish good credit, or perhaps actively trying to fix your credit, it is important to consider how any sort of action you take financially may impact those efforts. Our entire financial history is interconnected, and the consequences are not always direct or obvious.
For example, banks do not report information regarding consumer checking accounts to the credit bureaus. It is reasonable to assume that closing your checking account should not impact your credit score, right? Not exactly.
What happens when you close a checking account?
Banks do not report checking account activity to the credit bureaus, if your account is in good standing. Alternatively, closing it to transfer to a different bank or opening a joint account does not impact your credit score or history.
However, what if your checking account is not in good standing? What if there is a negative balance due to overdrafts and you close the account and walk away? Many consumers do so each year, assuming that their actions will not catch up with them. It is not that simple, though.
While your bank does not report bank account information directly to the credit bureaus, there is a service that consumer banks rely upon, which is similar to how creditors report to the credit reporting agencies. This service is called ChexSystems. If you close a checking account with a negative balance still outstanding, that information may be reported to ChexSystems.
If the balance remains outstanding long enough, banks may send your account to a collection agency, and they do report to the credit bureaus. In other words, that counts as two strikes against you.
What is ChexSystems and what do they do?
According to Bankrate, ChexSystems was created by banks and credit unions to help identify people who are not reliable to open accounts. This process applies people who abuse checking accounts, overdraw their accounts and then close them, or have multiple overdraws on accounts.
While banks will not report checking account information to any credit bureau, they may report to ChexSystems. The bank may report this information to ChexSystems if your account was closed with an outstanding overdraft balance, if you have a history of multiple overdrafts, if you were deemed to be abusing your account or ATM access, or if the bank suspects of any kind of fraud.
This type of activity can make it difficult for you to open other accounts because other banks refer to the ChexSystems record before approving any new account. ”If your name is reported to ChexSystems, you can expect to have that infraction on your history for up to five years. If you have more than one report on your name in the system, you will likely be unable to do any regular banking.”
Opening and closing accounts too often can be reported to ChexSystems. Banks may assume you will abuse the accounts if you repeatedly open and close them.
What is the impact of overdraft protection?
Another surprising way that your checking account may impact your credit report is via overdraft protection.
Banks often market overdraft protection as a perk because it offers a kind of “safety net.” Overdraft protection may be especially helpful if you make a mistake or run into a timing issue that causes you to overdraft your account unexpectedly. When the bank applies overdraft protection to your checking account, they are agreeing to cover your overdraft without penalty, up to the limitations or conditions spelled out in your agreement.
What the bank may not fully explain, however, is that overdraft protection is considered a line of credit. Adding overdraft protection to your checking account may result in a hard inquiry on your credit report, which may initially drop your credit score. If there are any issues later on and the bank decides that overdraft protection has been abused or your account has been closed with an outstanding balance, that line of credit may be subject to reporting to the credit bureaus.
Again, if the default results in the bank bringing in a collection agency, you can be sure they will report the issue to the credit bureaus.
How can you avoid any negative credit consequences when closing a checking account?
Quite simply, make sure your account is in good standing when it is closed. Try not to hop around opening and closing bank accounts over and over again if you can help it. Finally, while there is nothing wrong with using overdraft protection on your bank account, understand overdraft protection’s credit implications before assuming that it is simply a free perk on the account.