What is the best for borrowing money?
Overdraft protection and credit cards are essentially personal lines of credit. They advance you money that you have to pay back, often with interest.
In general, choosing between overdraft protection or a credit card depends on several factors, such as the fees involved and how you use the available credit.
Key points to remember
- Both overdraft protection and a credit card are personal lines of credit that lend you funds that you have to pay back with interest.
- Overdraft protection is usually attached to a checking account, ensuring that checks are not returned for insufficient funds.
- What works best for you depends on a variety of factors including the fees involved and how you use the funds.
How an overdraft works
If you have overdraft protection with your bank, you can spend more than the actual amount in your attached checking account. When you do, the check will not be bounced. Instead, the bank will honor it by advancing the amount to you, in effect. In exchange for this service, you will pay bank interest on the overdraft amount in your account.
Some overdraft lines of credit will charge you a fee for each overdraft, and some have an annual fee instead of or in addition to the overdraft fee. Since an overdraft is essentially a personal line of credit, the amount the bank will allow you to borrow will depend to some extent on your creditworthiness, as well as the bank’s policies.
Overdraft lines of credit and credit cards often come with late payment penalties. So whichever option you choose, make sure you make your payments on time.
How a credit card works
A credit card also works like a line of credit, specifically a revolving line of credit (that is, it is flexible and open-ended, as opposed to a fixed-term loan that must be paid back within. a certain delay). This line is as large as your credit limit, which is how much you can charge on the card.
Whenever you use a credit card, you are basically borrowing funds from the credit card company to purchase goods or services. When you receive your monthly statement, you then reimburse the company for the money they advanced to you.
Now, if you borrow money by making purchases with the card, and you can’t immediately repay that amount in full (if you start having an outstanding balance month-to-month, in other words, interest you will also be billed). amount. Credit card interest rates can vary widely depending on the card and your credit score. Many credit cards also charge an annual fee.
Discovered vs. Credit cards: which ones to use?
Choosing between overdraft protection or a credit card depends on several factors:
- Do you have access to both options?
- Do both options give you enough available credit to cover the amount you need to borrow?
- Which one has a lower interest rate?
- Are there any overdraft fees when you use the line of credit?
- Does either option charge an annual fee?
You will need to do the math for your specific situation to see which choice is the cheapest.
An example of overdraft against credit card
Suppose you need $ 1,200 for car repairs. Although you only have $ 200 in your account, you write a check to the garage for the full amount. With an overdraft line of credit, your bank will allow you to borrow money at 18% per annum (assuming there is no capitalization, interest paid annually) and pay a loan fee. overdraft of $ 12.50. If you want to pay off the loan within one year, you will need to pay a total of $ 180 in interest plus $ 12.50 in fees.
Through a credit card, you can borrow money at an introductory rate of 12% for one year (assuming there is no capitalization, interest paid annually), and the card no. has no annual fee. You will have to pay $ 144 in interest.
In this case, the credit card is the best choice. Of course, if the credit card charged you a higher annual percentage rate (APR) and / or annual fee, the benefit could go overdrawn.
The bottom line
Overdraft protection and credit cards have their pros and cons, and it’s impossible to generalize what is best for each situation. Typically, however, credit cards work best for planned or predictable expenses that you intend to pay off over time.
Overdrafts work best in emergency situations, saving you the embarrassment and hassle of a rejected check for insufficient funds.