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. What are the pros and cons of overdraft protection?

    The good news: Checks always clear. The bad: The bank will charge you an overdraft fee, even though you’re using your own ... 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. 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 >>
  4. How does your checking account affect your credit score?

    Learn how your checking account relates to your credit score, as well as what types of banking activities do and do not get ... 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

    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.
  6. Personal Finance

    5 Bank Fees You May Not Know About

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

    Should You Use Credit Cards To Fund Your Business?

    We give you 4 reasons to consider using a credit card instead of a business loan to fund your business, and how to be smart about it.
  8. Personal Finance

    The Basics of Lines of Credit

    Learn how a line of credit, hybrids of credit cards and normal loans, can help (and hurt) your finances, and how to find the best one to suit your needs.
RELATED TERMS
  1. Overdraft

    An extension of credit from a lending institution when an account ...
  2. Overdraft Protection

    Overdraft protection is a line of credit that banks offer to ...
  3. Daylight Overdraft

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

    A checking account is a deposit account at a financial institution ...
  5. Linked Transfer Account

    Accounts held by an individual at a financial institution that ...
  6. Credit Limit

    The amount of credit that a financial institution extends to ...
Trading Center