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Loan, Overdraft or Credit Card — Which is Right for Me?

Consumers have various options when looking to borrow money, from loans to overdrafts to credit cards. Each form of borrowing is suited to different purposes, so read on to discover which might suit your needs and financial circumstances.

Choosing the best way to borrow money can be confusing, especially when you’re looking for the cheapest option that caters for all your requirements.

Whether you are looking to finance an expensive item like a holiday, a wedding ring or home improvements, or you need to borrow money to cover some short-term cash flow problems, you will want to find the most suitable form of finance.

The three most common choices available to consumers are loans, overdrafts or credit cards. Each is a viable choice in the right circumstances, but which is best for your individual financial situation?

Loan or credit card or overdraft?

Read on to discover the features of loans, credit cards and overdrafts.

Loans

Personal loans allow you to borrow money over a set period of time. You’ll repay the full amount and any interest that builds up in monthly instalments. The interest rate is set at the beginning of the loan term, and will not change over its course.

What type of borrowing is a loan suitable for?

Loans tend to be used for longer term borrowing to pay for a significant expense — such as the cost of a wedding — rather than for short term borrowing. They allow consumers to spread the cost of spending over a longer period, thanks to their lengthy terms which usually range from one to seven years.

See our article on short-term vs long-term borrowing for a detailed guide on the differences between these lending options.

Interest rates on personal loans are fixed, so if users budget well they should be able to manage the repayments. Furthermore, loans can be arranged in as little as 24 hours.

A lender may not give you the best interest rates if your credit rating is not good. Lower interest rates will only be available to those with good credit ratings. Read our guides on credit checks and how to rebuild your credit history for more information.

Find out more about how APR impacts the amount you repay when borrowing with a personal loan.

Loans can be suitable for:

  • Home improvements
  • The cost of a wedding
  • Purchasing an expensive item

Pros and cons of loans

Pros Cons
  • Able to borrow larger sums of money
  • Fixed interest rates can make it easier to budget
  • Funds can be in your bank account within 24 hours
  • Long-term financial commitment
  • Interest rates can be high
  • Less flexible repayment than other forms of borrowing

If you think that a loan is the most suitable form of borrowing for you, read our article on everything you need to know about getting a loan.

Remember, if you can’t make your loan repayments your credit score could be damaged, which will limit your opportunities of taking out credit in the future. So, always think carefully before taking out a loan, and consider all your options.

Overdrafts

An overdraft is a banking facility which allows bank account holders to have a negative bank balance, meaning they can borrow small amounts from their bank. Overdrafts are meant for short-term borrowing, and with the 2020 changes to how overdrafts work, they could be one of the more expensive ways to borrow.

What type of borrowing is an overdraft suitable for?

Overdrafts were designed to be used as a way for bank account holders to resolve short term cash flow issues in between paychecks.

The rules as to how they are governed changed in 2020 to protect those with unarranged overdrafts being charged hefty day rates for borrowing money. The fees for unarranged overdrafts and unarranged overdrafts are now charged at one single rate.

Since the changes, most high street banks and challenger banks charge higher levels of interest. If you regularly rely on your overdraft for longer term borrowing it could become quite expensive, and it may be quite hard to get out of the red as your situation will be compounded by monthly interest charges.

If you’re already in this situation take a read of our guide on how to get out of your overdraft quickly.

Some lenders have decided not to raise their overdrafts in line with the enforced changes led by the Financial Conduct Authority, so consider switching banks to one that charges lower interest if you regularly use your overdraft.

Overdrafts can be used for:

  • Day-to-day spending
  • Resolving cash flow problems

Pros and cons of overdrafts

Pros Cons
  • Immediate access to funds if you have an overdraft set up; access can still be quick if not
  • Flexible borrowing
  • Good for short-term borrowing
  • Smaller amounts are available than loans and most credit cards
  • Interest rates can be high
  • They can be withdrawn by the lender at any time

Credit cards

Credit cards can sometimes have a bad name, and significant credit card debt is to be avoided when possible. However, credit cards can be a good option when consumers are looking to spread the cost of an item over a few months to make it more manageable.

What type of borrowing is a credit card suitable for?

Credit cards suit short-term borrowing, rather than long-term, and can be useful when you need money quickly, but don’t have an emergency fund.

Credit cards allow users to usually borrow between £1,000-£5,000, however, higher earners with good credit histories can apply for cards with a credit limit of £10,000 plus.

There are many scenarios where a credit card can be beneficial when consumers are looking to borrow money. For instance credit cards offer payment protection to consumers for when purchases don’t go according to plan. This could apply to faulty goods, flights being cancelled or a holiday operator going out of business.

0% purchase credit cards give consumers the ability to make purchases on credit cards without having to worry about rising interest costs.

Some credit cards also offer cashback and benefits to consumers. Benefits vary between different cards, but some cards allow users to collect points which can be redeemed elsewhere, in stores or to put towards hotel stays or flight costs.

When looking to choose a credit card it is important to choose a card based on the type of spending you are likely to be using it for.

Credit cards can be used for:

  • Spreading the cost of a large purchase with a 0% purchase credit card
  • Paying off another credit card with a 0% balance transfer credit card
  • Borrowing money with a 0% money transfer credit card

Pros and cons of credit cards

Pros Cons
  • Some cards let you borrow up to a certain amount interest-free
  • Flexible borrowing and repayments
  • Payment protection
  • Some cards offer rewards or cashback
  • Interest is added to the balance you owe monthly
  • 0% deals only run for short periods
  • Credit limit is set when you apply
  • Withdrawing cash is expensive

Compare loans, overdrafts and credit cards

Compare loans, overdrafts and credit cards as methods of borrowing money. Which you choose will depend on how much you want to borrow, what you want to spend it on, and how quickly you need the money.

Written by John Ellmore

    Published on 02-10-2020

    Updated on 08-10-2020

John Ellmore co-founded Know Your Money in 2004 and is a company spokesperson for consumer finance issues. John is committed to providing clear, accurate and transparent financial information.

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