Line of Credit vs Overdraft: How Each One Works in Canada

A line of credit and an overdraft both let you spend money you don't have yet, but they are not the same tool. A line of credit is a separate revolving account with its own limit, and it is usually the cheaper way to borrow for anything you will carry past a payday or two. An overdraft is a cushion built into your chequing account: handy for a short gap, expensive if you live in it. This guide explains how each works, what drives the cost, and how to choose. One thing up front: LoanGoose is a loan matching and comparison service, not a lender. We don't set rates and we don't make credit decisions.

What a line of credit actually is

A line of credit is a revolving account. Your financial institution sets a maximum, you draw what you need, you pay interest on the outstanding balance, and as you repay, the room comes back. Draw, repay, draw again. The limit does not reset to zero the way a personal instalment loan does.

There are two main shapes. An unsecured line of credit is approved on the strength of your income, credit history and existing debts. Because the lender has nothing to seize if you stop paying, the rate tends to sit above a secured option. A secured line of credit is tied to an asset, most often your home, which makes it a home equity line of credit. At federally regulated lenders, a home equity line of credit is generally limited to 65% of appraised property value, with total secured lending against the property usually capped at 80% (OSFI Guideline B-20).

That trade-off is the whole story: security buys a lower rate and a bigger limit, but it puts your home behind the debt. That is a serious step, and worth talking through with a licensed professional before you sign anything.

What an overdraft actually is

An overdraft is not a separate account. It is permission for your chequing balance to dip below zero, up to a limit the institution sets. There are two versions. Arranged overdraft protection is agreed in advance, so a payment that would overdraw the account may still go through, and you pay interest on the negative balance. An unarranged overdraft happens when nothing is in place: the payment may be returned, and you may face a fee from the institution plus another from the merchant.

Overdraft interest usually runs higher than a line of credit, and fees often matter more than the rate. A per-use fee or a monthly fee charged on a small negative balance can cost more than the interest itself. The exact charges live in your account agreement and vary by institution, so read the agreement rather than assume.

Line of credit vs overdraft, side by side

Two practical differences stand out. First, control: with a line of credit you decide when to draw, while an overdraft happens by accident as often as by plan. Second, scale: overdraft limits are usually small, so a line of credit is generally the tool for anything larger or longer.

What each one costs you

Both products charge interest on a balance, and both sit under the same outer limit in federal law. The Criminal Code sets the criminal rate of interest at 35% per year, calculated by a defined method that aggregates interest and certain charges (Criminal Code s. 347 — criminal rate of interest). That is a ceiling lenders must stay under, not a rate anyone should aim to pay.

Beyond the rate, watch three things:

• How interest is calculated. Daily interest on a line of credit means paying a few days early saves a little. Overdraft interest usually builds on the daily negative balance.
• Fees. Ask for the per-use and monthly fees on overdraft, and whether the line of credit carries an annual or setup fee.
• What happens if you miss a payment. Both products can affect your credit report and your ability to borrow later. Ask the institution directly rather than guessing.

If you think a fee or a rate has been applied incorrectly, you have somewhere to go. Complaints about federally regulated financial institutions go to the Financial Consumer Agency of Canada, while most other lenders are licensed and supervised by the provinces (FCAC — complaints).

When each one makes sense

• Use an overdraft for a gap measured in days, like a bill landing before a deposit clears. Repay it quickly and it is just a convenience.
• Use a line of credit for a known expense you will repay over several months: a car repair, a course, or consolidating a few balances into one payment.
• Think twice about either if the balance never reaches zero. A permanent overdraft or a maxed-out line of credit is a signal that the budget, not the product, is the problem.
• Consider a personal instalment loan if you want a fixed payment and a set end date. A revolving limit makes it easy to repay slowly forever (FCAC — personal loans).

Whichever way you lean, it helps to see the product next to your actual monthly budget, because the cheapest option is the one you can clear (FCAC — debt and borrowing).

Credit reports, and what happens after a slip

Canada has two national credit reporting bureaus, Equifax Canada and TransUnion Canada, and you can get a free copy of your credit report from each one (FCAC — credit reports and scores). A line of credit is typically reported as its own account, so a balance sitting near the limit can weigh on your file even when you pay on time. Overdraft reporting varies by institution.

If a debt has grown past what you can manage, the honest move is to talk to someone early. Only a licensed insolvency trustee can administer a consumer proposal or a bankruptcy, and trustees are regulated by the Office of the Superintendent of Bankruptcy Canada (Office of the Superintendent of Bankruptcy Canada). A consumer proposal stays on your credit report for three years after completion, or six years from filing, whichever comes first. A first bankruptcy stays on your report for six years after discharge.

How to choose

Ask yourself three questions. How long will I carry this balance? How big is it? What happens if my income dips next month? Short and small points to an overdraft. Longer and larger points to a line of credit, ideally unsecured if you can qualify for a rate you can live with. If the answer to the third question is "I would be in trouble," the real answer is to borrow less, or not at all.

Whatever you pick, compare more than the headline rate. Look at fees, how interest is calculated, and what closing the account involves. These decisions depend on your own circumstances, and for anything significant, especially borrowing against your home, it is worth speaking with a licensed professional first.

Frequently asked questions

See the FAQ section below for quick answers on approval, credit reporting and closing an account.

LoanGoose is a loan matching and comparison service, not a lender. The lowest rates are only available to the most qualified applicants.