Overdraft or credit card: Which is better to borrow money?
We explore how overdrafts and credit cards work to help you decide which option is right for you.
Credit cards and overdrafts are both popular ways to borrow money. However, they work in different ways, have slightly different uses and each has its own list of pros and cons. Our guide aims to help you choose which one could work for you.
How credit cards work
A credit card is a flexible credit line that enables you to borrow funds up to your agreed credit limit as required. Your provider decides your credit limit based on factors like your credit history and income. Credit limits tend to range between £500 and £12,000.
Your credit card provider sends you a bill each month to show you how much you owe, and you’ll then need to make at least the minimum payment. This will typically be 1% of your balance, plus that month’s interest, or a fixed sum of £5, whichever is greater.
If you pay off your balance in full each month, you won’t pay any interest. If you don’t, interest is usually charged on the remaining balance. However, some cards offer 0% introductory deals, allowing you to avoid paying interest for a number of months.
What type of borrowing is a credit card suitable for?
Different credit cards are designed for different purposes. Some enable you to spread the cost of “big ticket” items interest-free, but you can also use a credit card for everyday spending and pay off the balance in full each month. If you do this, it’s worth looking for a credit card with rewards or cashback.
Other credit cards let you shift over debt from an existing credit card and pay it off more cheaply.
Credit card pros and cons
- You can borrow money for purchases, and as long as you repay the balance in full each month, you won’t pay interest.
- You might be able to take advantage of a 0% deal, helping you to spread the cost of a purchase or repay existing debt more cheaply.
- Credit card purchases over £100 (and less than £30,000) are protected by section 75 of the Consumer Credit Act. This means your card provider is jointly liable with the retailer if something goes wrong, and you should get your money back.
- Credit card limits are usually higher than overdraft limits.
- You might be able to earn rewards such as air miles or cashback.
- Interest rates can be high if you don’t pay off your balance in full each month.
- Cash withdrawals are expensive – as well as being charged a fee, you will also be charged interest from the date of the transaction.
- The best deals are reserved for those with excellent credit scores, so if yours isn’t up to scratch, you could be rejected or pay a higher interest rate.
- If you don’t make your repayments on time, you can harm your credit record.
- It can take a few days for your credit card to arrive, so you won’t always be able to spend straight away.
How overdrafts work
An overdraft enables you to borrow money through your bank account. It works by letting you spend more money than you have in your account, which can be useful if you need a little extra to cover unplanned expenses. Your overdraft limit could be between £250 and £2,000, for instance.
However, an overdraft is still a type of loan and must be repaid – with interest added. There are 2 types of overdrafts: arranged and unarranged. Arranged overdrafts are those you’ve pre-agreed with your bank, while unarranged overdrafts are when you spend more money than you have in your account without arranging it with your bank in advance.
New rules introduced in April 2020 mean that banks can no longer charge higher fees for unarranged overdrafts than arranged overdrafts. Instead, banks must charge a single annual interest rate to make it easier for consumers to compare charges. Interest rates now sit in the region of 19–40%, with most at the upper level.
What type of borrowing is a credit card suitable for?
An overdraft can be useful for last-minute purchases or cash withdrawals. You can also use an overdraft to pay direct debits and standing orders.
Overdraft pros and cons
- Unlike a credit card, you can use an overdraft to pay direct debits and standing orders as well as to withdraw cash.
- You can repay the debt as and when you can – there are no monthly repayments.
- They are quick to apply for – in fact, you’ll often get one automatically when you apply.
- Interest rates can be very high, making it expensive.
- You usually can’t borrow as much as you can with a credit card.
- Because there are no fixed monthly repayments, it can take you a long time to repay.
- Your bank can take your overdraft away at any point.
What is the difference between an overdraft and a credit card?
One of the key differences is the time it takes to access your funds. If you already have a current account, you can often get approved for an overdraft the same day or the following day. By contrast, if you apply for a credit card and are accepted, you’ll usually need to wait a few days to receive your card and PIN in the post.
However, credit cards usually enable you to borrow a larger sum than an overdraft, so they can be more useful if you need to pay for big-ticket items. Credit cards also offer purchase protection; overdrafts don’t.
On the whole, overdrafts are best for short-term borrowing, while credit cards can be used over a longer period of time.
What to consider when choosing an overdraft or a credit card
If you’re choosing between an overdraft or a credit card, it’s worth asking yourself the following questions:
- How much do you need to borrow? You can typically borrow sums of up to £3,000 or £4,000 with a credit card, but if you have a good credit history and high income, you can borrow even more. By contrast, you might only be able to borrow £500 to £2,000 with an overdraft.
- How soon do you need the funds? Getting approved for an overdraft is generally much faster than applying for a credit card. You can often have the funds in your account in a matter of hours.
- What are you using the money for? Remember that with a credit card, you get valuable purchase protection which can be useful when paying for a holiday or buying furniture, for example. However, if you’re paying a bill, some providers charge a fee if you use a credit card for the payment, so an overdraft will be more suitable.
- Will you be withdrawing cash? It’s best not to withdraw cash on a credit card as you will usually be charged a fee plus interest.
- How much interest will you be charged? Interest rates on overdrafts are generally higher than on credit cards.
Sam is looking to pay for a holiday to Greece and wants to spread the £2,500 cost over several months. He already has an overdraft on his bank account, but it charges a high rate of interest. Instead, he decides to apply for a 0% purchase credit card which lets him spread his payments over 18 months interest-free. He pays off £140 a month and has cleared the debt by the time those 18 months are up.
Cathy needs to pay for some unexpected repairs to her car, which cost £500. Payday is still a week away, and she needs the funds fast, so she speaks to her bank about an arranged overdraft. The bank agrees to give her a £1,000 overdraft, and she receives the funds the same day. She repays the money once her salary has been paid into her account.
Frequently asked questions
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