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.

A credit card is also, essentially, a line of credit. If you borrow funds by making purchases with it that you can’t immediately pay in full, you’ll also be charged interest. Credit card interest rates can vary significantly depending on the card and your credit score. Many credit cards also charge annual fees.

Comparing the Two

In general, whether it makes more sense to borrow 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.

An Example

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 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. Pros and Cons of Overdraft Protection

    The good news when you sign up for overdraft protection is that checks always clear. The bad news is that the bank will charge ... Read Answer >>
  2. 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 >>
  3. How does NetSpend overdraft protection work?

    Discover how NetSpend overdraft protection works and how it charges for each overdraft transaction. Read Answer >>
Related Articles
  1. IPF - Banking

    When Good People Write Bad Checks

    Overdraft protection can help when you overestimate your balance, but it will cost you.
  2. IPF - Banking

    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

    Top Checking Accounts With No Overdraft Fees

    Choosing the right checking account could save you hundreds of dollars in fees every year.
  4. 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.
  5. Personal Finance

    Build Your Credit Score

    Here are four good ways to build your credit score when you're starting from scratch. Do it right and you'll end up with excellent credit.
  6. Personal Finance

    Credit Cards to Help You Recover from Poor Credit

    A poor credit score can put a huge damper on your finances. Thankfully using the right credit card can help boost your score and turn around your finances.
  7. Personal Finance

    Everything You Need To Know About Credit Card Rates

    Understanding credit card rates will help you choose the right credit card, and avoid any unpleasant surprises.
  8. Personal Finance

    Should you increase your credit card limit?

    Understand the fundamentals between credit scores, credit card limit, and your credit utilization rate. Find out why you should ask for your credit limit increase and the benefits that follow.
RELATED TERMS
  1. Overdraft

    An overdraft is an extension of credit from a lending institution ...
  2. Overdraft Cap

    An overdraft cap is the maximum dollar limit that a bank will ...
  3. Evergreen Loan

    An evergreen loan is a loan that does not require the principal ...
  4. Daylight Overdraft

    A daylight overdraft is when a bank withdraws more money than ...
  5. Checking Account

    A checking account is a deposit account at a financial institution ...
  6. Credit Card Debt

    Credit card debt is a type of unsecured liability which is incurred ...
Trading Center