A:

If you have an overdraft line of credit at your bank, you can spend more than the amount in your checking account. In exchange for this service, you’ll pay the bank interest on the amount by which you overdraw your account. Some overdraft lines of credit will charge you a fee for each overdraft, and some have annual fees instead of, or in addition to, overdraft fees. An overdraft line of credit is essentially a personal line of credit, so the amount the bank will let you borrow will depend on the bank’s policies and your credit worthiness.

If you borrow money by charging purchases you can’t afford to a credit card, you’ll also pay interest. Credit card interest rates can vary significantly depending on the card and your credit score. Some credit cards also charge annual fees.

Suppose you need to borrow $1,200 for car repairs.

Through an overdraft line of credit at your bank, you can borrow the money at 18% annually (assuming no compounding, interest paid annually) and pay a $12.50 overdraft fee. If you want to pay the loan back within a year, you’ll need to pay a total of $216 in interest plus $12.50 in fees.

Through a credit card, you can borrow the money at an introductory rate of 12% for one year (assuming no compounding, interest paid annually), and the card has no annual fee. You’ll need to pay $144 in interest.

In this case, the credit card is the better choice. In general, whether it makes more sense to borrow money via an overdraft line of credit or a credit card depends on several factors:

1. Do you have access to both options?

2. Do both options give you enough available credit to cover the amount you need to borrow?

3. Which one has a lower interest rate?

4. Is there an overdraft fee when you use the overdraft line of credit?

5. Does either option charge an annual fee?

You’ll have to do the math for your specific situation to see which choice is less expensive.

In addition, overdraft lines of credit, like credit cards, have penalty APRs. This means that if you miss a payment, your interest rate can increase significantly, so whichever option you choose, be sure to make your payments on time.

RELATED FAQS
  1. What is the difference between overdraft and cash credit?

    Learn about the uses of the terms ''overdraft'' and ''cash credit,'' and how they represent different financial arrangements ... Read Answer >>
  2. What are some examples of overdraft protection?

    Establish overdraft protection plans to ensure that your bills are paid on time. Use overdraft protection carefully to avoid ... Read Answer >>
  3. How does your checking account affect your credit score?

    Learn how your checking account is related to your credit score, as well as what types of banking activities do and do not ... Read Answer >>
  4. Can a checking account go negative?

    Find out about negative checking account balances and the ramifications. There is a price to pay, but smart consumers can ... Read Answer >>
  5. Can a checking account affect your credit score?

    Find out if having a checking account can have a negative impact on your credit report. Generally, it doesn't, but there ... Read Answer >>
Related Articles
  1. Personal Finance

    When Good People Write Bad Checks

    Overdraft protection can help when you overestimate your balance, but it will cost you.
  2. Personal Finance

    4 Ways to Ditch Bank Overdraft Fees

    At $35 a pop, overdraft fees can mount up quickly. Here are 4 different strategies for avoiding them.
  3. Personal Finance

    What's The Difference Between Overdraft And Cash Credit?

    Overdraft and cash credit are forms of borrowing. With both, the lending institution lets the borrower withdraw funds she has no claim to, usually in small amounts.
  4. Personal Finance

    Bank Overdraft Changes: What You Need To Know

    New laws to protect consumers should be in place by the summer. Find out what will change and how it could affect you.
  5. Personal Finance

    Top Checking Accounts With No Overdraft Fees

    Choosing the right checking account could save you hundreds of dollars in fees every year.
  6. Personal Finance

    Overdrafting

    An overdraft occurs when money is withdrawn from a bank account in an amount that exceeds the funds available in the account. Banks often permit this as a form of short-term loan to the account ...
  7. Insights

    Credit Unions Rake In Record Overdraft Revenue

    Banks and credit unions saw overdraft fee income rise to the highest levels since the Fed prohibited automatic ATM and debit card charges.
  8. Personal Finance

    4 Reasons To Increase Your Credit Card Limit

    It seems contrary to smart financial planning, but increasing your credit limit can actually be a smart move.
  9. Personal Finance

    5 Bank Fees You May Not Know About

    Banking regulations have recently changed and fees are following suit.
  10. Personal Finance

    Terrible Credit Score? Try These Credit Cards

    When your credit is less than stellar you have fewer choices. But some are still better than others. Here's our read on which cards to get.
RELATED TERMS
  1. Credit Card Arbitrage

    Borrowing money at a low interest rate from a credit card then ...
  2. Late Fee

    A charge a consumer pays for making a required minimum payment ...
  3. Credit Card Balance

    The amount of charges, or lack thereof, owed to the credit card ...
  4. Credit Utilization Ratio

    An input used in determining a person's credit score. It is the ...
  5. Balance Chasing

    The gradual lowering of a consumer’s credit limit by a credit ...
  6. Bank Credit

    The amount of credit available to a company or individual from ...
Trading Center