The battle for Christmas spending: credit cards vs overdrafts

Sarah Finney 12 November 2014

An estimated 13.7 million bank customers in the UK say they have used an unauthorised overdraft in the last three months according to a surprising new survey by Thinkmoney.

With the cost of living still rising faster than wages, there may be times when we all need to borrow. So, with Christmas just around the corner, what will win the fight for the cheapest form of short term borrowing: overdrafts or credit cards? Are credit cards still the "cheaper" option? Join us ringside...

In the red corner: Overdrafts

Most current accounts will allow you to take out more money than you have in your account, using an overdraft. However, with a reputation for high interest rates and fees, overdrafts have traditionally been seen as one of the most expensive ways to borrow over the short term.

With the introduction of the faster current account switching service, the current account market is becoming more competitive. Gone are the days of sticking to one bank; now overdraft rates and fees are getting increasingly more attractive (along with accounts that come with perks, interest on balances, and preferential rates on other products) as banks try to attract customers on the move.

Here are some of the knockouts and knockdowns of using an overdraft to cover any excess spending this festive season:

The knockouts

  • Some overdrafts are interest and fee-free – usually advertised prominently as this is a real selling point in a crowded market. Check the terms carefully though and make sure you know how long any interest or fee-free periods last for.
  • Overdrafts can be a flexible way to borrow that you can dip in and out of, and you'll usually only pay fees and/or interest on the amount you borrow, for the duration of your borrowing. Banks don't usually charge you for paying off your overdraft earlier than expected, unlike some loans.
  • They can be quick to get set up and some banks let you apply online. Applications are typically assessed quickly too.

The knockdowns

  • Different accounts offer different combinations of interest and fees payable on overdrafts. Work out how much it will cost based on your circumstances, bearing in mind that interest rates can vary. Your current account provider may be able to provide a personalised representative example to help.
  • Exceeding an arranged overdraft (going into an unarranged or unplanned overdraft) can incur steep fees and/or interest, so you'll need to keep an eye on your spending.
  • Providers are allowed to ask for overdrafts to be repaid at any time, although typically they only do this if you get into severe financial difficulty.
  • Some current accounts don't come with overdraft facilities, or some may have qualifying criteria, such as a minimum spend or a monthly account fee to take advantage of them. Check with the bank before you set up an account.
  • While your existing current account provider may offer you a better deal if you speak to them, moving to a better overdraft usually involves switching current accounts.

In the blue corner: Credit cards

Lenders aren't pulling any punches when it comes to competing for customers. Increasing 0% interest periods for new purchases and balance transfers, as well as packaged benefits such as cashback, make for interesting comparisons when shopping around for a new credit card deal. Here's how credit cards measure up for short term borrowing:

The knockouts

  • In contrast to overdrafts, most credit cards aren't tied to another account, so you're relatively free to shop around for the best deal.
  • Providing they are used responsibly, credit cards can be a useful and convenient way to borrow money for the short term, and many come with incentives to do so, above and beyond most overdrafts: cashback, interest free periods and low charges abroad are just some of the perks lenders are offering.
  • Paying off a credit card on time, particularly if you use a credit-building card, could improve your credit rating over time, unlike overdrafts.
  • Like overdrafts, you typically only owe interest and/or fees on what you spend – unlike a loan.
  • Purchases are often insured when paid for with a credit card, making cards useful for things like booking holidays or paying for home improvements.

The knockdowns

  • Like overdrafts, failing to pay off a credit card on time can affect your credit rating, which could hinder your ability to get credit in the future.
  • Also like overdrafts, the actual amount you're able to borrow and the rate of interest charged may vary depending on your circumstances.
  • Credit cards may incur surcharges with certain vendors, where current accounts typically don't.

Overdrafts vs credit cards: the decider

Round for round overdrafts and credit cards are going toe to toe. Although credit cards will probably always be thought of as the cheaper option, particularly with huge 0% interest periods, overdrafts are fighting back and could be a good option if you're shopping around for a current account that won't charge you the earth for dipping into the red this season.

For most, the answer might be a combination of a credit card for bigger purchases and an arranged overdraft for when everyday purchases slip over during the festive period. Whatever you choose, it's essential to work out what you can comfortably afford to pay back, and then use that to shop around for deals that are right for you.

Borrowing isn't always the answer. Planning ahead can help you stay out of the red altogether, and it's better to be prepared financially for big purchases or the unexpected by keeping a rainy day or emergency fund in savings.

Read more about building up an emergency fund