Overdraft protection and credit cards are both, in essence, personal lines of credit. They lend you money, which you must return, usually with interest.
In general, the decision between overdraft protection and a credit card is influenced by a number of variables, including the costs associated and how you utilize the available credit.
- Overdraft protection and credit cards are both personal lines of credit that lend you money that you must return with interest.
- Overdraft protection is often associated with a checking account, ensuring that cheques are not rejected due to insufficient money.
- Which is best for you is determined by a number of criteria, including the costs involved and how you intend to use the cash.
How an Overdraft Works
If your bank offers overdraft protection, you may spend more than the amount in your linked checking account. When you do this, the check will not bounce. Instead, the bank will honor it, effectively advancing you the sum. You will pay the bank interest on the amount you overdraw your account in return for this service.
Some overdraft credit lines may charge you a fee for each overdraft, while others will charge you an annual cost instead of, or in addition to, overdraft penalties. Because an overdraft essentially creates a personal line of credit, the amount you may borrow will be determined in part by your creditworthiness as well as the bank’s own restrictions. 1
Late payment penalties are common on both overdraft lines of credit and credit cards. So, whatever choice you select, be sure to pay on time. 1
How a Credit Card Works
A credit card may also be used as a line of credit, especially a revolving line of credit (meaning it is flexible and open-ended, as opposed to a finite loan that must be repaid within a certain period).That line is the same size as your credit limit—how much you may charge on the card.
When you use a credit card, you are essentially borrowing money from the credit card business in order to purchase products or services. You return the firm for the money it advanced you when you get your monthly bill.
Now, if you borrow money by making purchases with the card and are unable to quickly return that amount in full—in other words, if you begin carrying an outstanding debt from month to month—you will be charged interest on that amount. Interest rates on credit cards might vary greatly based on the card and your credit score. Annual fees are also charged by several credit cards. 2
Overdraft vs. Credit Cards: Which to Use?
Choosing between overdraft protection and a credit card is influenced by various variables, including:
- Do you have access to both possibilities?
- Do both solutions provide you with enough credit to pay the amount you need to borrow?
- Which of them has the lowest interest rate?
- When you utilize the overdraft line of credit, is there an overdraft fee?
- Is there an annual price for either option?
You’ll have to perform the arithmetic for your particular scenario to determine which option is less costly.
An Example of Overdraft vs. Credit Card
Assume you need $1,200 for auto repairs. Despite the fact that you only have $200 in your account, you write the garage a check for the whole amount. Your bank will allow you to borrow the money at 18% annual interest (assuming no compounding and interest paid yearly) and pay a $12.50 overdraft charge via an overdraft line of credit. If you want to pay off the loan in a year, you’ll need to pay $180 in interest plus $12.50 in fees.
You may borrow the money using a credit card for a 12% introductory rate for one year (assuming no compounding and interest paid yearly), and the card has no annual fee. You must pay $144 in interest.
The credit card is the best option in this scenario. Of However, if the credit card has a higher annual percentage rate (APR) and/or an annual fee, the overdraft may be advantageous.
The Bottom Line
Both overdraft protection and credit cards have advantages and disadvantages, and it is hard to say which is best in every scenario. Credit cards, on the other hand, are often preferable for scheduled or predictable spending that you want to pay off over time.
Overdrafts are most useful in emergency circumstances, sparing you the humiliation and inconvenience of having a check refused due to insufficient money.
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