A personal loan, an overdraft and a credit card all let you use money that must be repaid. That is where the similarity ends.
A loan gives you a lump sum with an agreed repayment schedule. An overdraft lets your current account move below zero. A credit card gives you a reusable limit that can be used for purchases and, usually at a higher cost, cash withdrawals.
The cheapest option cannot be identified from the product name alone. You need to consider the actual rate, fees, repayment pattern and total cost offered to you.
With poor credit, the rates available may be higher and the limits may be lower. You might also be declined. Check affordability before applying and avoid making several full applications within a short period.
What happens to the same £500?
-
Personal loan
- You receive £500 as a lump sum.
- You make agreed repayments over a fixed term.
- The balance is cleared at the end of the term.
-
Overdraft
- Your bank account falls to minus £500.
- Interest is normally charged while the account remains overdrawn.
- Money paid into the account automatically reduces the amount being used.
-
Credit card
- The card provider pays for a purchase costing £500.
- The balance appears on your next statement and you must make at least the minimum payment.
- Paying only the minimum can keep the debt running for much longer.
No interest rates are attached to this example. It shows how each product works, not which one costs least.
The quickest comparison
These are general characteristics. Individual products and agreements differ. Always read the terms provided by the lender, bank or card issuer.
How a personal loan works
A personal loan provides one amount of money at the start. You then repay it, usually with interest, over an agreed number of months or years.
The repayment is normally fixed, although some loans have variable rates. The payment schedule is designed to clear the balance by the end of the term.
This structure can make budgeting easier because you know:
- How much you borrowed
- The normal monthly repayment
- How many repayments are required
- The total amount repayable
- When the agreement should end
A loan may be worth considering for one planned expense where the amount is known and fixed repayments are affordable.
However, a lower monthly payment does not automatically mean a cheaper loan. Extending the term usually means paying interest for longer, so choosing the right repayment term matters. Compare the total repayable and the APR as well as the monthly amount.
You cannot normally reuse money that has been repaid without making another application.
How an overdraft works
An overdraft is borrowing attached to a current account. If the balance falls below zero, the account is overdrawn.
An arranged overdraft has a limit agreed with the bank. An unarranged overdraft happens when the account goes below zero without an agreed facility or moves beyond the agreed limit.
Interest is normally calculated on the amount being used. Under FCA overdraft rules, banks must price arranged and unarranged overdrafts using a single interest rate rather than daily or monthly fees. When wages or other money enter the account, they reduce the overdrawn balance automatically.
This makes an overdraft flexible, but it can also hide how long the debt has been outstanding. There is no normal final repayment date forcing the balance to reach zero.
An overdraft may be considered for a short and temporary gap when the account holder knows how it will be cleared. It is less suitable as permanent extra income.
The bank may review the facility and its terms. Do not assume an overdraft limit will always remain available.
If an account is £500 overdrawn and £1,200 in wages is paid in, the new balance becomes £700 before other transactions. The overdraft has been repaid, but normal spending could cause the account to become overdrawn again.
Repeatedly entering an overdraft soon after income arrives can be a sign that normal spending is relying on borrowed money.
How a credit card works
A credit card provides a reusable credit limit.
The card can be used to make purchases. Each statement shows the balance, the minimum payment, the due date and other important information.
Paying the full statement balance by the due date can avoid purchase interest on many standard cards, depending on the terms. If only part of the balance is paid, interest may be charged and the remaining debt moves into the next statement period.
Only making the minimum payment can keep the account up to date, but it may clear very little of the balance. Continued spending can prevent the debt from reducing at all.
The Financial Conduct Authority treats an account as being in persistent debt when, over an 18 month period, the customer has paid more in interest, fees and charges than they have repaid from the amount borrowed. Card providers must contact customers at defined stages and provide further support where required. The FCA’s credit card rules explain the process.
Credit cards and purchase protection
A credit card has one feature that a normal personal loan or overdraft does not provide.
Section 75 of the Consumer Credit Act may protect qualifying purchases costing more than £100 and up to £30,000. The credit card provider can share responsibility with the seller if goods are faulty, not supplied or misrepresented.
The rules are more detailed than the price range alone. The protection can depend on what was purchased, who bought it and how the payment was processed. MoneyHelper explains how you are protected when you pay by card.
Do not use a credit card solely to gain protection if the resulting balance would be unaffordable.
Cash withdrawals on a credit card
Using a credit card to withdraw cash can be expensive. A cash withdrawal may attract a fee and interest can start immediately rather than after the normal period for purchases.
Cash withdrawals can also be recorded differently from ordinary card spending and may be considered by future lenders.
If you need money in your bank account rather than a way to pay a retailer, check carefully whether a credit card cash withdrawal makes sense.
Why comparing APR alone is not enough
APR is useful, but these products do not all behave in the same way.
A loan has an agreed amount and term. An overdraft balance can change daily. A credit card balance changes as the card is used and repaid.
Compare the following:
- The actual rate offered
- Any fees that apply
- How much will be borrowed
- How long the balance is likely to remain
- The required monthly payment
- The planned monthly payment
- The total expected cost in pounds
- Whether the rate is fixed or variable
- What happens if a payment is late
- Whether the borrowing has a clear end date
Do not compare a loan’s representative APR with an assumed overdraft or card rate. Use the personal figures supplied by each provider.
The repayment structure matters
The major difference between these products is not access to money. It is what happens after the money is used.
A loan creates a schedule
The borrower follows a series of payments intended to clear the debt by a particular date.
An overdraft follows the bank balance
Money entering the account reduces the overdraft, but spending can take the account below zero again.
A credit card follows the borrower’s payments
The borrower must make at least the minimum payment, but can normally pay more. Paying more usually clears the balance sooner and reduces interest.
This is why two products with similar rates can produce very different total costs.
Compare the borrowing shape
Choose the situation closest to yours to see how the shape of each product fits it.
Illustrative example
Representative example: Borrowing £1,000 over 18 months with an annual interest rate of 59.97% fixed, you would make 18 monthly repayments of £89.22. The total amount repayable would be £1,605.96. The total interest charged would be £605.96. Representative 79.5% APR variable.
This feature explains general product differences. It does not recommend a product or assess whether borrowing is suitable. No answers are saved or transmitted.
Real advantages and disadvantages
Personal loan
Possible advantages
- Clear repayment amount
- Agreed end date
- Useful for one known expense
- Total repayable is disclosed before signing
Possible disadvantages
- A fixed payment must be made each month
- Longer terms can substantially increase the total cost
- The exact rate offered may be higher than the advertised rate
- Repaid money cannot normally be borrowed again without another application
Arranged overdraft
Possible advantages
- Flexible access through an existing current account
- Interest applies to the amount actually used
- Incoming money immediately reduces the balance
Possible disadvantages
- No automatic date by which the debt will be cleared
- Normal spending can put the account back into the overdraft
- The interest rate can be expensive
- The bank may review the facility and its terms
Credit card
Possible advantages
- Flexible repayments above the minimum
- Available credit can be reused after repayment
- Purchase interest may be avoided by clearing the statement balance under the card’s terms
- Qualifying purchases may receive Section 75 protection
Possible disadvantages
- Minimum payments can clear the balance very slowly
- Continued spending can make repayment harder
- Poor credit cards can have high rates
- Cash withdrawals can involve immediate interest and fees
What if you have bad credit?
Poor credit does not automatically decide which product is suitable. It can, however, affect which products are available, the rate offered and the credit limit. Lenders also look at more than your credit score.
A person with poor credit may receive:
- A smaller loan
- A higher loan rate
- A lower overdraft limit
- A credit card with a low limit and high APR
- No offer at all
Check eligibility before making a full application where a genuine soft search is available. Confirm that the check will not leave a visible hard search before submitting it. Our guide to soft and hard searches explains the difference.
Do not make several applications simply to see which one is accepted.
When none of the three is suitable
A loan, overdraft or credit card may all be unsuitable if you:
- Cannot cover essential living costs
- Are already missing repayments
- Need new credit to make existing credit payments
- Have no realistic plan to repay
- Are depending on an uncertain future payment
- Would be left with no room for unexpected costs
In this position, comparing credit products does not solve the underlying shortfall. MoneyHelper’s bill prioritiser shows which commitments to deal with first, and its free Debt Advice Locator can put you in touch with an adviser. Its overview of options for borrowing money covers alternatives beyond these three products.
Frequently asked questions
Not always. A loan may have a lower rate, but it may run for longer. An overdraft may cost less for a very short period but become expensive when used continuously. Compare the actual pound cost over the time you expect to borrow.
A credit card can be cheaper if a genuine interest free purchase period applies and the full balance is repaid before it ends. If interest is charged and only minimum payments are made, it may cost more and take longer to clear.
An overdraft is a form of credit, but it works through a current account. It does not usually provide the fixed repayment schedule and end date associated with a personal loan.
There is no single best option. Availability, rates and limits depend on the provider’s checks and the applicant’s circumstances. Compare affordability, total cost and repayment structure before applying.
Some cards allow money transfers, while cash withdrawals are also possible. Fees and interest may apply. These transactions can be more expensive than ordinary purchases, so check the exact terms first.
An overdraft can appear on a credit file. How it is used may be considered by future lenders. Exceeding a limit or failing to repay when required can also cause problems.
Minimum payments keep the account from immediately falling behind, provided they are paid on time. They may reduce the balance very slowly, especially if the card continues to be used.
Applications for loans, overdrafts and credit cards can involve credit and affordability checks. Eligibility tools may use soft searches, while a full application normally involves a hard search. The provider should explain which type of search will be used.
Compare the structure before the rate
Choose a product only after understanding how the balance will be repaid. Look at the actual cost in pounds, the required payments, the likely repayment time and what would happen if your circumstances changed.
LoansForBadCreditUK.co.uk is a credit broker, not a lender. We do not provide overdrafts or credit cards and cannot guarantee that any form of borrowing will be available. This guide provides general information and is not a personal recommendation.