Overdraft vs Loan
Over the years, credit facilities have become readily available to the masses. Consumers can buy their dream home or finance their small business, all in one tap. With so many options of credit available — credit cards, bank loans, overdrafts and EMIs — it becomes necessary to know the difference between them.
Unless a consumer is not fully aware of the route of credit they have opted for, they may end up in worse conditions than when they started. Thus, it is vital to know the differences and pros and cons of the potential credit facility one avails to ensure that you make the right decision every time.
Through this article, we want our readers to understand the differences between two of the most common sources of credit. We will answer questions like which is better between overdraft and loan? And which option can be exercised when and by whom? Read and find out everything you need to know about personal loans vs bank overdrafts.
Let us talk about definitions.
A personal loan is a financial product where the bank lends money to an individual for a predetermined period. This amount — called the principal — has to be repaid within a fixed period with additional interest. The repayment takes place in the form of regular monthly installments. In most cases, these loans are collateral-free.
Bank overdraft is an agreement between lenders and borrowers allowing borrowers to withdraw more money than what is available in their accounts. It is a short-term loan offered by banks to current account holders. Overdrafts allow withdrawals up to a predetermined limit secured against financial assets held by the account holder.
What is their type and source of capital?
Personal loans are obtained for the immediate need of funds but have the option of long-term repayment tenures. Because a personal loan does not generally require collateral, it is considered an unsecured form of debt.
On the other hand, using an overdraft facility helps meet short-term liquidity requirements and offer only short-term repayment options. Because of this, overdrafts get referred to as a credit facility.
How is the interest calculated?
Interest rates in the case of personal loans are variable and depend upon the borrower’s credit score. The interest gets charged on the principal amount on a yearly basis and is paid in monthly installments by the borrower.
The interest rate charged on bank overdrafts is calculated on a daily, monthly or quarterly basis as agreed upon by both parties. If consumers do not overdraw any amount, they are not liable to pay any interest.
Process and speed of releasing funds.
The process of obtaining a personal loan is a lengthy one. Interested borrowers have to satisfy multiple criteria for eligibility, submit necessary documents and go through a vetting process for approval. From the date of application to the date of approval — it may take several days or even weeks for the funds to get disbursed.
Making use of the overdraft facility is a lot simpler. Funds can be borrowed via overdraft within a few hours. The process can be smoother depending on the borrowers’ relationship with their bankers.
Tenure of loan and flexibility of repayment.
Personal loans are extended for a tenure of 2–60 months and must be repaid in equal monthly installments. The lending authority may also charge an additional fee in the form of prepayment and processing charges.
For overdrafts, there is no fixed period, and the borrower can repay as per their convenience at the cost of incurring higher interest as compared to traditional loans. No additional charges are levied.
Looking at the pros and cons.
Both personal loans and bank overdrafts have their advantages and disadvantages. While one of them is better in one scenario, the other comes out on top elsewhere. That is why it is vital to understand clearly — the strengths and weaknesses of both facilities.
Pros of Personal Loans:
- Owing to the different kinds of loans available, borrowers can obtain more funds according to the purpose of seeking money.
- If the borrower has a good credit record, they can enjoy lower interest rates and longer repayment periods.
- Because one cannot borrow more on the same loan, consumers only use loaned funds for a set purpose. That limits overspending.
Cons of Personal Loans:
- In the case of personal loans, the interest keeps on getting accrued on the amount due. Because of this, opting for longer repayment schedules may do more harm than good because the interest gets compounded over time.
- Missing a payment on a personal loan will severely harm the borrower’s credit score.
Pros of Bank Overdrafts:
- The process of availing credit through overdraft is fast. Because of this, if the borrower is ever in need of funds immediately, overdrafts are the better option.
- The borrower can decide on the overdraft limit as per their requirements. That gives them additional freedom in managing their finances.
- Funds borrowed through overdrafts are available immediately for use as and when required by the customers.
Cons of Bank Overdrafts:
- Exceeding overdraft limits results in additional interest expenses. Because the overdraft interest rate is higher than a personal loan, overspending becomes more expensive.
- The repayment period for overdrafts is short.
Now that we know how personal loans and bank overdrafts work, we can consider their pros and cons and choose what is best for us. Overdrafts are the better option for short-term, everyday requirements. On the other hand, personal loans are the cheaper option for long-term financing requirements.