InRevolving Credit, we looked at what revolving credit is and where it is most applicable. Today, we continue our analysis of three new financial products, namely the difference between a credit card, an overdraft and a line of credit.
How does revolving credit work?
In appearance, credit cards are almost identical to the debit cards we almost all have. With both, you can shop online as well as in physical stores, but the main difference appears to be the funds available to you.
With a debit card, you use your own money that you have previously deposited with the bank. With a credit card, you borrow money from the card issuer (financial institution) up to a pre-set limit. That is, you are given access to a line of credit and agree to repay the money with interest by a certain date according to agreed terms.
A credit card is preferable to a debit card when you receive your earnings are on different dates, unexpected expenses often pop up, or you want to take advantage of an opportunity (usually some type of offer/promotion) that is time-sensitive but you don’t have enough finances. However, it is important that you are disciplined and repay the amount according to the agreed terms so that you are not charged penalty fees.
What is an overdraft?
An overdraft is a service that allows you to borrow extra money through your current account. Occurs when you don’t have enough money in your account to cover a transaction or withdrawal, but the bank authorizes the transaction anyway. For example, you have 30 BGN in your account, but renewing your fitness card costs 50 BGN. In this case you use an overdraft and your balance becomes -20 BGN.
In other words, an overdraft is a credit authorization from the financial institution that is granted when your account reaches zero. In most cases it is agreed and has a pre-set limit which is held as an arranged overdraft. It is important to know that fees are usually payable when using this service. Use it wisely as an extra buffer to the amount in your bank account that will allow you to make urgent transactions even when you don’t have the money, not as an amount to rely on every month.
What is a line of credit?
A line of credit is a flexible loan provided by a bank or financial institution that, like a credit card, offers you a set amount of money at your disposal – funds you can use when and how you want. Lines of credit are most often used by businesses due to working capital needs or to take advantage of strategic investment opportunities when lack of sufficient finance does not allow it.
As with the loan, the line of credit accrues interest as soon as the money is borrowed. However, what is different is that in the case of a line of credit, the interest rate payable is charged only on the amount of credit used and not on the entire amount available on the line of credit.
With this type of loan, you can repeatedly withdraw funds and repay them within the pre-agreed period, and of course there are penalty fees if you fail to repay the amount by the due date. There is also a fee for maintaining the line of credit for the duration of the contract.
Which one to choose?
The availability of such a variety of credit products is driven by the different financial needs of individuals and businesses. If you want to rely on your own funds but occasionally run short, then an overdraft is a sensible choice because you’ll be able to make your purchases or pay your bills without limiting your budget to a salary. But if your income varies from month to month, a credit card may be a better solution because you won’t be relying solely on personal funds and paying overdraft fees.
A line of credit is a better option for companies or individuals with relatively larger financial needs. It is most often used for working capital such as the purchase of materials, supplies, equipment, payroll, etc.