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What’s the difference between overdraft and a line of credit?

A question came up in conversation recently about the difference between overdraft and a line of credit. If you’re not sure, I hope this is helpful.

Overdraft protection covers you if you have too much money coming out of your account. Say too many bills go through all at once and your account dips below zero. The overdraft will cover you until you can top it back up. That way no cheques bounce and you save the non-sufficient funds charges (and all that hassle!). Sometimes banks charge fees, interest or both. You have to set it up with your bank first though, it’s not automatic.

A line of credit is borrowing money from a pre-authorized credit account. It’s like a credit card that is just there like a bank account. You can dip into it when you need to. Usually it has good interest rates (low), like prime plus one.

What’s prime all about? The prime rate is set by the Bank of Canada. Banks have money flowing in and out just like your account does, and to tide them over until their thousands of accounts settle every day, the Bank of Canada loans them money at a set interest rate — the prime rate. Banks usually use that rate as a guideline and add extra to it when they loan out money — that extra is profit.

What rate you get depends on your bank, your negotiating skills and your credit rating (or credit score). Every time you use credit, you’re building your rating – the information gets filed automatically. If you’re renting an apartment, arranging a mortgage on a house or applying for a credit card, all those companies are going to check your credit rating to see if they can trust that you’re going to pay them on time.

It’s a good idea to check your rating every now and then, because mistakes can cost you. Check it for free at Equifax or TransUnion. A bad credit score means you’re going to pay more interest, because the company loaning you money is taking a chance on you and they want to be compensated to make it worth their while.

Talk to your bank about what they offer and how overdraft or a line of credit would work for you. Of course, if you have issues with overspending you might need one (overdraft) more than the other (another credit source!).

Don’t let the bank talk you into more credit than you need either. That’s like getting the meal deal for only a little bit more, which is tempting, but you know the fries and cola aren’t good for you.

(Note to self for future blog topic — how a budget is like a diet.)

So there you have it, some basic definitions of a couple common financial tools. If you have any suggestions for other explanations you’d like to see, please let me know in the comments.

Happy money-ing!

In the news

Here’s a quick roundup of a few interesting things.

US Banks Finally Getting Sued for the Great Recession Crash

Remember back in 2008/2009 when the US banks lent people money to buy homes they couldn’t afford, then raised interest rates and foreclosed? Miami nearly went bankrupt — if people lose their homes they’re not paying property taxes. But no one went to jail because for years before the crisis the banks and other financial institutions changed the rules in their favour (deregulation). Now Miami is trying to sue the banks. This will be interesting. Read all about it in the Washington Post

Canadian Banks Overcharging Customers

Meanwhile here in Canada the big banks are turning themselves in, admitting they overcharge customers and paying them back. Here’s the key point in this article – it is just too hard for average people to figure out what’s going on with their money. Most of our financial information comes from people trying to sell us something, which makes unbiased decisions much more difficult. Read all about it on CBC

Hillary & Donald: It’s Almost Over

Finally, is anyone else out there waiting to see if election anxiety affects the markets? When people get nervous they start pulling their money out by selling off their stocks, which sends prices lower. That’s what I love about the whole financial and economic scene – it’s not about numbers, it’s about people, and whether they have hope or fear for the future. I won’t direct you to any article about the American election though; I think we’ve all had enough over the past 18 months.

Money in a sock drawer

A friend of mine sent me a link to a CBC story about CIBC selling negative-rate bonds for the first time in Canadian history. Negative-rate bonds means they are guaranteed to lose money, and people are buying a lot of them – CIBC raised almost $1.8 billion. Crazy, eh?

Here’s how a negative-rate bond works. When you buy a bond, you’re basically loaning money to the business or government, and they promise to pay you the full value at a certain time in the future. To make you more interested in giving them your money, they give you interest payments along the way. Really, it’s a big IOU and you’re the loan shark.

When the bond has a negative rate, you’re giving say $100 to the business/government and they promise to pay you $95 back. Why would you do it? Because you think the world is going to hell in a hurry and this may be your best bet. At least you’ll have $95.

Like the loan shark you are, if you’re not paid back in time you can take the assets they put up as collateral, they can raise cash by charging their customers more or they can call in their own debts to help them pay you back (after you break their knees, of course). What assets do Canadian banks have? Mortgages. Ah, the plot thickens!

Canadian banks are strong and strongly regulated. The government wouldn’t let them get into the pissing contest between the US and the UK when those countries were deregulating themselves into a tizzy trying to create new ways of making money that eventually led to the 2008 economic collapse. So we trust our banks. When you’re scared, you turn to people and institutions you trust.

That’s why people are handing money over knowing they’ll get less back in the future. They’re scared.

Emotions are running high right now. Here in Canada business investment is slow and the Fort McMurray wildfires took a chunk out of our economic growth when oil production stopped, according to the Conference Board of Canada. Horrible things are happening all over (another attack in France; failed coup in Turkey; race relations in the US; the UK second-guessing its Brexit vote). C’mon, Donald Trump is a presidential candidate fer cryin’ out loud.

Fear, greed and hope. That’s what runs the economy.

My friend wants to keep his money tucked away in his sock drawer. Can’t say I blame him. (Of course there’s inflation, but that’s a post for another day.)