Many people will find themselves choosing between an overdraft or credit card when it comes to borrowing. Both are popular ways to borrow money for a variety of different reasons, but they also have fundamental differences that you will want to be on top of. In this article, we will guide you through all of the benefits and pitfalls of a credit card, overdraft or neither to help you find the best borrowing option.
What is a credit card?
A credit card is a borrowing and spending tool that allows you to buy something with the card and pay for it later. The money you are spending is borrowed from the card provider and does not come from your bank account, as it would with a debit card purchase. Your spending builds up as a balance on the card that you will need to pay off. Most cards have an interest-free period of at least 56 days, though some come with special 0% offers that last many months. You will not need to pay any interest if you pay off the balance within this timeframe.
If you do not pay off the card in full, you will need to make at least the minimum payment to avoid late repayment fees and other extra charges. We go into more detail on credit card basics in our article ‘What is a credit card?’.
Some specialist credit cards offer services beyond purchases, such as money and balance transfers. Learn more by reading our article ‘Which credit card is best for me?’.
What is an overdraft?
An overdraft is a credit facility that can be added to your current account. It allows you to spend more money than you actually have in your account, though you will have to pay interest on the amount you are overdrawn by. You will usually need to apply for an overdraft with your bank, but in some cases your account may come with an overdraft when you first open it.
An overdraft facility that is pre-agreed with your bank is called an authorised or arranged overdraft, whereas simply spending more than you have in your account without notifying the bank would put you into an unauthorised or unarranged overdraft. Arranged overdrafts usually come with an agreed limit that you will need to stick to.
An overdraft can be useful, but it can also be an expensive way to borrow money. If you are using your overdraft frequently, read our article ‘Top-5 ways to clear your overdraft for good’.
Pros and cons of a credit card
Credit cards can be versatile financial tools due to the variety of scenarios they can be used in, but they will not always be the right option. Here are the key advantages and disadvantages to think about:
Pros of a credit card
- Buy now, pay later - What you buy with the card, you pay for later. This could give enough time for your salary to be paid, allow you to prioritise higher-interest debt or spread the cost of a purchase.
- Spread the cost of what you buy - You could make a purchase on a credit card, then steadily clear your balance through equal monthly repayments. Your balance will usually start to grow with interest after 56 days unless you have a 0% purchase card. You can check out the best 0% purchase credit cards in our ‘Compare the Best 0% purchase credit cards’ article.
- Flexible borrowing - With a credit card, you pay back what you spend plus any interest, fees or charges. You can spend what you need – up to your credit limit – and pay back what you owe. Other forms of lending may lead to you over-borrowing and paying interest on money that you didn’t need.
- Interest-free borrowing - By paying off your balance before your interest-free period ends, you are essentially borrowing money for free. Learn more about interest on credit cards in our article ‘What does 0% interest, or APR, mean on a credit card?’.
- Earn rewards and cashback - Credit card spending can earn you back a percentage of what you spent in cashback, or allow you to build up reward points or airmiles. You can see the best offers in our article ‘Compare the best cashback and reward credit cards’.
- Free payment protection - Thanks to Section 75 of the Consumer Credit Act, you should be refunded if you do not get what you paid for when using a credit card. We explain your rights under Section 75 in more detail in our article ‘Section 75 of the Consumer Credit Act explained – plus how to claim’.
- Cover unexpected bills - Having a credit card means that there is a line of credit available should you need to make an emergency purchase or cover an unexpected bill.
- Build a credit history - Making regular purchases on a credit card and paying off the balance in full every month will fill your credit file with examples of good, reliable borrowing. We explain this process in more detail in our article ‘How to build your credit score with a credit card’.
- Clear expensive debt - Debt on a high-interest credit card can be transferred over to a 0% balance transfer credit card that does not charge any interest for a set period. There is more information in our article ‘What is a balance transfer credit card and how does it work?’.
- Consolidate debt - A 0% interest balance transfer card can be used to move debt from multiple credit cards onto one. This gives you the benefit of the 0% interest period having just one payment to make each month. Read our article ‘How to consolidate debt with a credit card’ to learn more.
Cons of a credit card
- The best cards require a good credit score - If you don’t have a good credit score, you may only be able to get the best cards on reduced terms, or you may only be able to get a basic credit card. You can find out which credit cards you are likely to be successful in applying for in our article ‘Check credit card eligibility: What credit cards am I eligible for?’.
- You will be in debt - Spending with a credit card means you will need to repay the money later. In some cases, being in debt can be stressful, expensive and cause long-term financial damage. If you are struggling with debt, we explain where to get help in our article ‘Where to get free debt advice’.
- Overspending - The best way to use a credit card is to spend money how you would with any other payment method, but many people struggle with the temptation to spend more and worry about it later.
- Interest rates can be very high - Clearing the balance before the interest-free period ends will mean you don’t pay any interest, however, the card will still have an interest rate that applies at the end of this period to any remaining debt.
- Taking out cash is expensive - Credit card providers will usually apply a high rate of interest to any balance you build up through cash withdrawals as soon as you withdraw the money, even if you are within a 0% offer period. This is one situation in which it is better to use a debit card than a credit card. We go over a few more in our article ‘Credit card vs debit card: Which should you use and when?’.
- Expensive fees and charges - In order to get the very best rewards from your card, you may need to pay a hefty annual fee. On top of standard charges like annual fees, most credit cards will charge late fees if you do not make your repayments on time.
We cover the pros and cons of getting a credit card in more depth in our article 'Credit card advantages and disadvantages'.
Pros and cons of an overdraft
An overdraft can be the best option in certain scenarios, but it can be limited. Here are some examples of why an overdraft might work or not work for you:
Pros of an overdraft
- Part of having a current account - An overdraft is an addition to your existing current account, so you do not need to apply for a new account with a new provider. This should make the process quicker and easier. If you do want a new account, head over to our article 'Best UK current accounts'.
- Quick decision - Many banks will be able to make an instant decision on whether your arranged overdraft has been approved or not because it will already have sufficient information about you as a current account holder.
- Flexibility - Much like with a credit card, you will only pay interest on what you spend and you do not have to borrow a lump sum that you may not need all of, as you would with a loan.
- Grace period - Some accounts will give you a short grace period – usually until the end of that day – to get out of your overdraft before interest charges kick in.
- No limits on where you can spend - An overdraft can be used almost anywhere for almost anything, as you can pay on your debit card or take it out in cash.
- No minimum monthly repayment - There is not a set minimum repayment structure for overdrafts, unlike the minimum payment on a credit card. You can read more about credit card minimum payments in our article ‘What is the minimum payment on a credit card?’.
- Avoid returned payments - If you accidentally leave too little in your bank account to pay a direct debit or standing order, you will go into your overdraft rather than fail to make the payment entirely. This can be especially useful for essential bills and rent payments.
Cons of an overdraft
- High interest rates - You may end up paying much more in interest than you would by borrowing an equivalent amount on a credit card, or even with a loan. This means that you will want to clear your overdraft as quickly as possible. We have some tips on how to do this in our article 'Top-5 ways to clear your overdraft for good'.
- Low limits - The limit on an overdraft is unlikely to match the very top credit limits on credit cards. This means that an overdraft may not be the right option if you need to spend a particularly high amount of money.
- No introductory offers - One of the most cost-effective ways to use a credit card is to utilise an introductory 0% interest offer or a new cardholder rewards bonus. These sorts of special offers do not exist with overdrafts, though you can get certain benefits for switching current accounts.
- You may lose your limit if you switch - There is no guarantee that your new bank will keep your previous overdraft limit if you decide to switch current accounts through the Current Account Switch Service.
- Can be precarious - Your current account provider can choose to cancel your arranged overdraft at any point, so it may not work as well as a credit card as a back-up or emergency funding source.
- Can damage your credit score - Consistently falling into your overdraft could damage your credit score in the long term as the debt will leave a mark on your credit file.
- No repayment structure - You will have to structure repaying your overdraft yourself, or with the help of a free debt advisor, as there is no inbuilt repayment plan.
- Limited purchase protection - As you will be spending on your debit card when you use your overdraft, you will not be covered under Section 75 of the Consumer Credit Act, though you will have some protection through the chargeback protection scheme.
Is a loan a good alternative to a credit card or overdraft?
A loan – whether an unsecured personal loan or a loan secured against something you own – will often be a viable alternative to a credit card or an overdraft. We cover the loan vs credit cards debate in our article ‘Is it better to get a credit card or a personal loan?’. We also break down the different types of loan in our artticle ‘Secured vs unsecured loans: Which is best for me?’.
You will often be able to borrow much more with a loan than you could through a credit card or overdraft, especially if you opt for a secured loan. You may also benefit from being able to select a loan term that makes your monthly repayments affordable, though you won’t get the interest-free period offered by some credit card providers.
Loans can be inflexible, as you will need to know how much you are going to spend before you apply. Any money you do not spend will still grow with interest. It can also be expensive to pay off a loan early due to early repayment fees. Overdrafts and credit cards are much more flexible as you only borrow what you need and can pay it off at any time. Read our articles 'What is an unsecured loan?' and 'What is a secured loan?' to learn more.
Overdraft vs Credit Card
You will likely find that a credit card is cheaper and more flexible than an overdraft in most situations. However, keep in mind that its usefulness will depend on your credit limit and the cost of what you want to buy. For example, a credit card will be a better option than an overdraft for a £300 washing machine, but only if you can get a high enough credit limit on your card. It will also be a much better option if you can get a long-term 0% interest credit card, but only a marginally better one if you are limited to a standard purchase credit card.
An exception may be that an overdraft could trump a credit card when it comes to unexpected bills, if that bill cannot be paid for with a credit card. However, in that situation, you could use a money transfer credit card instead.
You can check your eligibility for a range of different types of credit card in our article 'Check credit card eligibility: What credit cards am I eligible for?'.
