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Line of credit vs Overdraft

Line of credit or overdraft? We break down the features so you get the product that’s right for you.

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Personal overdrafts and lines of credit are flexible and convenient financing alternatives to standard personal loans and credit cards. However, they are often thought to be the same product, and the similarities between the two often make it difficult to choose. In the guide below, both are broken down so you can pick the right one for your needs.

What are lines of credit and overdrafts?

  • A line of credit is a personal loan that provides access to a specified credit limit. It allows you to withdraw up to and including that limit.
  • An overdraft is also a line of credit, but it’s attached to your existing transaction account. You have access to a certain amount of credit that becomes available when you exhaust the funds in your account.

What are the main differences?

Line of creditOverdraft
CostsInterest rates vary, but you only pay interest on the balance, not your credit limit. Establishment fees may apply.Overdrafts are unsecured, so variable rates usually apply. You only pay interest on your outstanding balance, but expect the account to attract monthly or annual fees. An establishment fee may also apply.
Loan termYou usually have a choice between an ongoing line of credit, where you can keep the account open as long as it’s in good standing, or one with a fixed term, normally between one and five years.Overdrafts do not usually have fixed repayment terms. Your account is ongoing as long as you make regular repayments.
Availability and accessLenders may provide a debit card that gives you access to your line of credit. Eligibility criteria vary, but they are usually available to those with good credit and can afford the repayments.You need to be an existing account holder or open a transaction account with the bank to have an overdraft. Then, you can access your overdraft automatically when your account funds are exhausted.

Which account is right for you?

If you are wondering which of the accounts will best meet your needs, ask yourself the following questions:

  • How often will I need access to the funds?
    A line of credit gives you immediate access to funds when you need it, but an overdraft can only be accessed when your funds are spent . This is an important point to keep in mind.
  • Do I need an “emergency” account?
    Overdrafts are typically thought of as “safety net” accounts. Even if your account goes into the negative, you are not charged overdraft fees; you are charged interest on the overdraft account balance.

Understanding the differences between these two accounts will help you decide which product is right for you.

Picture: Shutterstock

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