Is it cheaper to use a credit card or an overdraft?

Do you find yourself dipping into your overdraft regularly? Used well, an overdraft can be a good way to tide you over until your next pay day.

But often, banks will charge you interest or fees for slipping into the red. In some cases, you may find that using a credit card works out cheaper.

Interesting interest rates

Depending on who you bank with, you may have a pre-agreed overdraft that acts as a cushion if you spend more than you have in your account. This “Standard Overdraft Limit” (or authorised overdraft) is set when you first open your account or ask for an overdraft.

If you spend more than your standard limit, or if you don’t have an agreed overdraft, you will fall into your unauthorised overdraft. You should try to avoid this type of borrowing.

Typically, nowadays banks charge a set fee for each day you’re overdrawn. These charges can be as much as £10 a day. There are usually caps on how many times they can charge you these daily fees in a month though – sometimes around eight to 10. But, some banks do still charge interest as well as these fees.

On top of this, banks often charge a one-off monthly fee for going into your overdraft in the first place – even if it’s authorised. This can be around £6 to £10.

Some banks will offer you a ‘buffer’ zone, which protects you if you accidentally go overdrawn by a small amount. Usually this is between around £10 and £25 and means you don’t have to pay interest or charges, but it depends on who you bank with. 

The cost of going overdrawn

So, to give you an example, we’ll take an average high street bank. If you go into an authorised overdraft with this bank by £150 in the last five days of the month, they would bill you £6. They have a buffer of £25 but charge interest of 1.5% on everything past this.

As long as you put the money back into your account before the end of the month, you would pay £7.88.

On the other hand, if you dip into your unauthorised overdraft with this bank by the same amount over five days, they would charge you the monthly £6, as well as £10 a day. Again, the same buffer of £25 applies but you will be charged 1.5% interest on the rest.

You would pay out £57.88 here – providing you put the money into your account so you’re back in the green.

You will have to remember to pay back both the £150 you dipped into your overdraft by, and the charges on top of that. And, bear in mind that if you only pay back a chunk, your overdraft will roll over to the next month and you could face further charges if you are still in your unauthorised overdraft.

Could a credit card be cheaper?

How much you pay on a credit card depends on your spending habits. It is perfectly possible to spend on a credit card and not pay any interest or fees. So long as you clear the balance in full at the end of the month, you won’t have to pay a penny.

But, if you get to the end of the month and you can’t yet repay the entire balance, just how much it costs depends on how much you spent, and how much you can repay.

For example, if you spend £150 on the Ocean credit card (which has a representative APR of 39.9%), you could end up paying in interest:

- £0 if you clear the balance in full at the end of the month,

-  OR £5.69 if you paid £75 in the first month, and £75 a month later.

Remember, this is on top of repaying the money that you spent on the credit card.

The Ocean credit card might be a cheaper way of borrowing than regularly spending in an unauthorised overdraft, but ultimately it depends on how regularly you use your overdraft and the interest rate and fees your bank charges. If you’re going to repay the entire balance at the end of the month anyway, using a credit card is a much better option.

However, it’s vital to remember to make at least the minimum repayment each month on your credit card, as not doing so can harm your credit history and cost you more. We recommend clearing the full balance, or as much as you can, every month as this will cost you the least amount of money.