Lines of credit and overdrafts are two forms of borrowing that can be made through your bank to help you pay off your loans. They are fundamentally similar in that they provide a new source of credit to help you to pay off other, higher-interest credit sources.
An overdraft allows your bank account balance to dip below zero, essentially enabling you to use it as a credit card once your balance hits zero. A line of credit, on the other hand, acts more as a separate credit account which you can dip into if you need funds.
Perhaps the most significant difference between these two sources of credit is the interest rate. A line of credit will usually have a relatively low interest rate. Overdrafts, on the other hand, tend to be much closer to the high interest rates you would find on credit cards. Overdrafts are also usually tethered to heavy fees, driving up their cost even further.
Should You Use a Line of Credit or Overdraft to Consolidate Debt?
There are some fairly significant advantages to using a line of credit or overdraft to deal with your debt issues, but they each have inherent risks that must be managed. Put simply:
- Reasonable Interest Rates. The interest rates on lines of credit are usually significantly lower than any other source of debt consolidation loans.
- Minimal Monthly Payments. Both overdrafts and lines of credit have very reasonable minimal monthly payments, often covering little more than the interest accruements, allowing you to pay off the loan when you’re able.
- Early Payment. There is no fixed payment schedule, allowing you to pay your consolidated loan off immediately, if possible, which minimizes the amount of interest you pay. Many other consolidated loans will have fixed schedules and penalties to paying off the loan early.
- An Endless Debt. Since the minimum payments only cover the interest, sticking to that manageable minimal payment means the debt will never go away. You will need to be disciplined with repayment.
- Lines of Credit Have Variable Interest Rates. The interest rate for a line of credit is usually ‘floating’, which means that it’s tied to the ‘prime’ rate. If the prime rate goes up due to market fluctuations, your minimal payments may increase significantly. Interest rates have been low for years, and as a result, many analysts believe they are due to spike again.
- Overdrafts Are Expensive. While the minimum payments can be more manageable than credit cards, overdrafts tend to have rates similar to credit cards, and often carry hefty fees. If not carefully managed and repaid quickly, overdrafts can become just as burden some as your credit card debt.
Our Best Advice
There’s no such thing as a ‘one-size-fits-all’ solution to debt management. If you find yourself in debt and would like to discuss your options, contact us for a free consultation.