Overdraft vs credit card: which is better?

Hi! Thanks for writing!  I want to make sure I understand your question so that I answer it correctly.  I think you are asking if it makes more financial sense to overdraft your debit/checking account or to use a credit card when you are short of money.  If I’ve missed the boat on what you are asking, please forgive and do write back again!

I’m assuming that you’ve set up some kind of overdraft protection on your debit/checking account at your bank and you also have a credit card. Most banks charge a fee for using overdraft protection, plus you need to have your own money sitting in another account for your checking account to pull from when you overdraft it. A credit card might charge anywhere from 12% to even 28% interest on balances carried.

So say you are short of cash for something you need to buy or pay for.  In our scenario, you realize you’re almost out of gas and have no cash with you. Your debit/checking account balance is at zero. You’ve got overdraft protection and you’ve got a credit card. Which is better to use?

First, the very best thing, if you have access to your bank on your phone and have money in your savings account, is to do a transfer of cash from savings to debit/checking account and then use your debit card for the cash. That’s free.  You can also call your bank and have them do it over the phone if you don’t have the account set up.  Transfers from one account to another for the same person at the same bank are instant. If you have money at another bank or institution, you can also transfer that over, but that will take at least a day and probably more, so it won’t solve your immediate problem.

However, I’m assuming that you probably don’t have money in the savings account at the moment either. In that case, which is better, overdraft or credit?

If you have the kind of overdraft protection that lets you deposit money that same day and thus avoid the overdraft fee, then you are probably better off using the debit card and hurrying to your bank to deposit cash to avoid a fee.  However, it may be that you don’t have any cash to deposit, in which case you will end up being charged a fee. Overdraft protection fees are usually about $35 per incident. So for $40 worth of gas, you’d have to actually pay $40 + $35 or $75, which would be a waste of money.

What about buying the gas with your credit card? If you use your credit card and pay it off when due, you incurred no fees or costs, so that would be great. That’s a simple solution that will cost you no extra. But if you use the credit card and don’t pay off right away, you’ll incur interest charges for as long as it isn’t paid off. At credit card interest rates that can cost a lot over time.

So the answer, is really “It depends.”  I wish there were a more concise “right” answer, but in this case, there isn’t.

One additional thing to consider is that using overdraft protection often, although it won’t likely damage your credit score, can negatively affect your record in ChexSystems, the service that banks access to check up on you when you want to open a bank account. So if you find yourself often running into cash flow problems, you are probably better off using your credit card and then hopefully paying off the credit card in full each month or at a minimum be sure to make the monthly minimum payment.

I hope this answer helps! Best wishes to you and thanks for writing!

Credit cards work better for planned or predictable expenses that you intend to pay off over time.

Overdrafts are more suitable for emergency situations, saving you the embarrassment and hassle of a check being rejected for insufficient funds, but the limits are generally lower than what you get with credit cards.