Credit card vs overdraft: which costs less and when each one applies

An overdraft is a type of credit that is linked to a bank account¹. A credit card is separate borrowing with its own limit. Both let you spend money you do not have, but they are built for different situations and the costs work in different ways.

The main practical difference is what each one is for. Overdrafts should only be used for emergencies or as a short-term option². Credit cards can suit planned purchases, especially if you clear the balance within the interest-free period or move the debt to a lower rate. Overdrafts are described as a very expensive way to borrow money due to high interest rates¹, and you will usually pay expensive daily interest to use one³.

Since 6 April 2020, banks have not been allowed to charge more for unarranged overdrafts than for arranged overdrafts, and daily or monthly overdraft fees were banned⁴. Rates must now be calculated as a percentage of the amount borrowed⁵. That change made overdrafts cheaper if you do not use them often or use them in small amounts, but it can make them more expensive for people who borrow larger sums over longer periods⁶.

Overdrafts suit emergencies, credit cards suit planned purchases

An overdraft is attached to your current account. Current accounts usually come with an optional overdraft, cheque book and debit card, with Direct Debits and standing orders available¹. The bank lets you spend more than your balance, sets a limit, and charges interest for using the overdraft, with no other charges¹. Because it is linked to the account you use every day, it is easy to slip into without deciding to borrow.

A credit card works differently. You get a separate limit, and you choose when to use it. That makes it better suited to a planned purchase you can repay over a set period, or to a one-off cost you want to spread. It also gives you extra protection on eligible purchases, which an overdraft does not.

The two are not interchangeable. An overdraft is repayable on demand, so a bank can ask for the whole amount back in one go¹⁰. A credit card balance is repaid on a schedule you control, subject to minimum payments. If you are choosing between them for a specific cost, the question is whether you can clear the balance quickly and whether the purchase needs protection.

How a credit card works

A credit card gives you a credit limit, and you can spend up to that limit. Some credit cards have a credit limit, meaning you will be charged if you go over it¹¹. Each month you get a statement and must pay at least the minimum. If you clear the full balance by the due date, you usually pay no interest on purchases.

Interest on a card is charged at different rates depending on what you do. There is a purchase rate for when you use your card to buy things, a balance transfer rate for when you move what you owe on one card to another, and a cash transaction rate for when you use your credit card to take money out of a cash machine or get cashback at a till¹². Each rate applies to a different kind of transaction, which is why the same card can be cheap for one use and expensive for another.

You cannot be charged extra for using a credit or debit card¹³. That surcharge ban means the price you see is the price you pay, whether you use a card or cash.

If you are paying someone for work, paying by credit card rather than cash gives extra protection, and you may be able to get your money back if something goes wrong¹⁴. That protection is one of the clearest differences between the two ways of borrowing.

What each one costs: interest, fees and charges

Overdraft costs are now simpler than they were. Interest on all overdrafts is charged at a single annual interest rate (APR), making it easier to compare charges between accounts². There are usually fees or interest if you spend more than you have in your account, including if there is not enough to cover a Direct Debit or standing order¹⁵. The bank will charge you interest on a daily basis and can ask that the overdraft is cleared on demand¹⁶.

The rate you pay varies. The effective interest rate on interest-charging overdrafts was 22.21% in March 2024⁷. Credit union current accounts offer access to borrow money using an overdraft, normally with daily interest up to 42.6%⁸. Some older sources describe a monthly fee and a setting up fee for an overdraft, which can make it an expensive way to borrow money¹⁷, though the 2020 rule change banned daily and monthly overdraft fees⁴.

Credit card costs depend on how you use the card. If you clear the balance each month, purchases are usually interest-free. If you carry a balance, interest is charged, and the rate depends on the type of transaction¹². Firms are required to allocate repayments to the debt subject to the highest rate of interest¹⁸, which means your most expensive debt gets cleared first.

Arranged or unarranged overdraft: what changes

An arranged overdraft is one you have agreed with your bank in advance. The bank sets a limit, charges interest for using it, and there are no other charges¹. You will be charged much less if you agree the overdraft beforehand¹³.

An unarranged overdraft is different. These are also known as unplanned or unarranged overdrafts and happen when you spend more than you have in your bank account without agreeing it in advance, including going over the limit of an authorised overdraft². An unarranged overdraft is a regulated credit agreement that arises as a result of a personal current account becoming overdrawn in the absence of an arranged overdraft, or the firm making available funds which exceed the limit of an arranged overdraft¹⁰.

The rules changed in 2020. Since 6 April 2020, banks have not been allowed to charge more for unarranged overdrafts than for arranged overdrafts, and daily or monthly overdraft fees were banned⁴. For personal current accounts, banks and building societies can no longer charge more for an unauthorised overdraft than for an authorised overdraft¹⁰. Where a customer has an arranged overdraft on a personal current account with a rate of interest above zero, the unarranged overdraft must be charged at a rate computed, structured and presented in an identical manner, although the level of the rate may be lower¹⁹.

The 2020 changes to overdrafts mean the end of unarranged overdrafts as a separate, more expensive product. Banks cannot increase interest and fees once you reach your overdraft limit⁶.

Protection on purchases: where a credit card differs

This is the clearest practical difference between the two. Paying by credit card gives extra protection under Section 75 of the Consumer Credit Act⁹. The credit card company has equal responsibility with the seller if there are any problems with the items you have bought²⁰.

The cover has limits. Section 75 card protection applies to credit card purchases where the cost was more than £100 and less than £30,000⁹. Items costing over £100 and under £30,000 are covered under the Consumer Credit Act²⁰. The protection only applies to credit card purchases, not debit card purchases²¹. It does not apply to charge cards either⁹.

An overdraft gives you no equivalent protection. If you pay for something from your current account, even if the account is overdrawn, you do not get Section 75 cover. That is why paying by credit card rather than cash gives extra protection when you are paying for work¹⁴, and why using a credit card to book a package holiday is also a good idea, as you will be given extra protection under Section 75²².

You might have more protection if you paid for something with a credit card²³. For a purchase you might need to dispute, that protection can matter more than a small difference in interest.

Effect on your credit file

Using an overdraft does not automatically damage your credit file, but how you use it can. Your credit rating can be affected if you often go over your overdraft limit or owe too much on your overdraft⁶.

Missing payments has a wider effect. Missing payments to credit cards, unsecured loans, catalogues, overdrafts and store cards can affect your credit rating, which would make it harder to get credit in the future²⁴. Payments to credit cards, unsecured loans, catalogues, overdrafts and store cards are not seen as priority payments²⁴, which means they sit lower in the order of debts to deal with if money is short, but that does not make missing them harmless.

Both overdrafts and credit cards appear on your credit file. Lenders look at how much of your available credit you are using and whether you keep within limits. Staying within an agreed overdraft limit and clearing the balance helps; going over the limit or carrying a large balance for a long time does not.

If you are struggling with overdraft or card debt

Certain types of borrowing, such as overdrafts, revolving credit on your credit card and payday loans, charge higher interest²⁵. If you are going into your overdraft every month, it may be a sign that you need free, expert debt advice²⁶.

There are steps you can take. If you have credit card debt, the first thing to do is stop using the credit card you want to pay off, so the amount you owe stops growing and it is quicker to repay²⁷. For an overdraft, one option is to repay the balance using credit with a lower interest rate, such as a balance transfer to a credit card or an affordable loan²⁶. A balance transfer moves the debt to the card, usually for a fee, and you then repay the card.

If you have an interest-free overdraft with the same bank as other debts, you could treat such debts as priorities so that you keep the overdraft, because if the bank starts charging interest your overdraft could increase very quickly²⁸. Credit debts such as bank loans, credit cards and overdrafts are usually a lower priority than debts to your university or college or council tax, because they cannot be enforced by evicting you from your home, sending you to prison or disconnecting an essential service²⁸. Common examples of non-priority debts include credit cards, bank loans and some overdrafts³⁰.

If you are worse off after the April 2020 overdraft changes, you can contact your bank, which might reduce or waive interest, offer a continuation of overdraft borrowing at the current rate of interest, or agree on a repayment programme possibly including a personal loan². Under the FCA's overdraft repeat use rules, options a firm could identify may include advice on budgeting and money management, forbearance and other support including reducing or waiving interest and other charges, refinancing to an alternative credit agreement on more favourable terms, or agreeing staged reductions in the overdraft limit and balance³¹.

You can switch current accounts even if you are overdrawn. You can switch using the Current Account Switch Service even if you are overdrawn². Some providers will even let you switch if you have a large overdraft debt outstanding, but there may be a charge to do this²⁹.

Free, confidential and independent advice is available from a debt adviser³². StepChange, Which? and Citizens Advice all offer free debt advice resources³³. If you owe money to HMRC, you can also get free, confidential and independent advice from a debt adviser³².

Who regulates overdrafts and credit cards

Both are regulated by the Financial Conduct Authority. Credit cards are regulated under the Consumer Credit Act 1974, the Payment Services Regulations 2009 and the FCA's Consumer Credit Sourcebook (CONC)¹⁸. Overdrafts are covered by CONC rules, including the overdraft charging and repeat use rules¹⁰. The FCA's consumer credit lending rules apply where a firm has entered into a current account agreement where the account-holder may overdraw without a pre-arranged overdraft or exceed a pre-arranged overdraft limit and this would be a regulated credit agreement³⁴.

The regulator changed in 2014. In April 2014, the OFT was closed and its consumer credit responsibilities were transferred to the FCA³⁵. Credit unions are regulated by the Financial Conduct Authority³⁶.

The Consumer Credit Act reform covers credit cards, loans, overdrafts, store cards, high-cost credit loans and hire purchase³⁵. The word "overdraft" may not describe any running-account credit agreement except one enabling the debtor to overdraw on a current account³⁷.

If you have a complaint about an overdraft or credit card that the provider has not resolved, you can take it to the Financial Ombudsman Service. The ombudsman can look at complaints about credit borrowing, including payday loans and similar products³⁸.