What's a better way to borrow money: overdraft or credit cards?

By Amy Fontinelle AAA
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 are the pros and cons of overdraft protection?

    If you sign up for overdraft protection and link your checking account to your savings account, a credit card or an overdraft ...
  2. Can I get a balance transfer if I have bad credit?

    Transferring funds from one credit card to another is often possible with bad credit, but it will likely cost you in interest ...
  3. What are the different types of cash advances?

    Find out the different types of cash advances along with their different features to determine which option, if any, is best ...
  4. Does a cash advance hurt my credit score?

    Find out if a cash advance will hurt your credit score and how your credit report and requests for new credit can be affected ...
RELATED TERMS
  1. Overdraft Cap

    The maximum dollar limit that a bank will send to another financial ...
  2. Overdraft Protection

    A line of credit that banks offer to their customers to cover ...
  3. Overdraft

    An extension of credit from a lending institution when an account ...
  4. Debt Snowball

    A method of debt repayment in which debtors pay off their smallest ...
  5. Asset Valuation Review (AVR)

    A process that establishes an estimate of the value of a failed ...
  6. International Finance Corporation

    The International Finance Corporation is an organization dedicated ...
Related Articles
  1. Credit & Loans

    Bank Overdraft Changes: What You Need ...

  2. Economics

    Indian Banking Regulations -- What You ...

  3. Credit card balance transfers can help pay off debts – but they can cost you. Here are some other approaches worth checking out.
    Credit & Loans

    4 Debt-Busting AlternativesTo Balance ...

  4. A new poll finds what financial tools Americans are most thankful for -- both sexes say the product they value most is the venerable savings accounts.
    Savings

    Giving Financial Thanks In Thanksgiving ...

  5. Handled correctly – and very carefully – a promotional credit card balance transfer offer can save you money. Here are some of the best deals around now.
    Credit & Loans

    Best Credit Cards For Making Balance ...

Trading Center