Overdraft vs Personal Loan: What is the Difference

Life can be unpredictable; unexpected events like sudden medical emergencies or natural calamities can lead to significant financial burdens. Having an emergency fund can help manage such unexpected expenses. However, the costs may sometimes exceed what your contingency fund can cover. Fortunately, you can rely on various credit facilities available today in such financial crises.

Among the most popular credit options are loans and overdrafts. Many people mistakenly believe these two types of credit are the same. In reality, they are quite different.

Understanding their distinctions is crucial in determining which credit facility fits your needs.

Overdraft loans Vs Personal loan

What is an Overdraft loan or Overdraft facility?

An overdraft is a short-term credit facility available to individuals and companies with a current account. It allows the account holder to withdraw more money than is currently in the account up to a specified credit limit. Interest is charged on the overdraft amount, which is the excess withdrawn. Overdrafts are usually secured by fixed deposits held by the account holder with the bank or financial institution, and the credit limit is typically a percentage of the fixed deposit amount.

Features of an Overdraft

• Flexible Borrowing: You can withdraw funds as and when needed, up to the approved limit.
• Interest on Utilised Amount: Interest is charged only on the amount you withdraw, not the entire overdraft limit.
• Revolving Credit: As you repay the withdrawn amount, your available limit is restored, like a credit card.
• No Fixed Repayment Schedule: Repayment can be made at your convenience, although banks may require periodic interest payments

What is a Personal loan?

A personal loan is an unsecured loan that you can use for various purposes, such as consolidating debt, covering medical expenses, or funding a major purchase. Unlike secured loans, personal loans do not require collateral, which means they are granted based on your creditworthiness and ability to repay. They typically have fixed interest rates and repayment terms, making it easy to manage your monthly payments. Personal loans are popular due to their flexibility and relatively quick approval process.

Read more about: What is a Personal Loan and its Benefits?

Features of a Personal Loan

• Lump Sum Disbursement: The entire loan amount is disbursed at once.
• Fixed Interest Rate: The interest rate is usually fixed for the duration of the loan.
• Structured Repayment: Repayment is made through EMIs over a specified tenure, typically 1 to 5 years.

Difference Between Overdraft and Personal Loan

Understanding the difference can help you choose the right credit facility based on your financial needs and repayment capacity. Let's check these.

1. Nature of Credit Facility

• Overdraft: An overdraft is a short-term credit facility linked to a current account. It allows you to withdraw more money than what is available in your account up to a predetermined limit.
• Personal Loan: A personal loan is a lump sum borrowed from a bank or financial institution, which you repay in fixed monthly instalments over a set tenure.

2. Repayment Terms

• Overdraft: Flexible repayment terms. You can repay the amount as and when you have funds available.
• Personal Loan: Fixed repayment schedule with monthly EMIs over a set period, typically 1 to 5 years.

3. Purpose

• Overdraft: Ideal for short-term financial needs and managing cash flow gaps.
• Personal Loan: Suitable for larger, one-time expenses such as medical emergencies, weddings, education, or travel.

4. Secured vs. Unsecured

• Overdraft: Often secured against fixed deposits or other assets.
• Personal Loan: It is generally unsecured, based solely on your creditworthiness and income.

Also read: What Is Secured Loan - Meaning & Definition

5. Usage Flexibility

• Overdraft: Offers flexibility as you can withdraw and repay any amount within the credit limit. Interest is charged only on the amount you use.
• Personal Loan: You receive the entire loan amount upfront and start repaying through fixed monthly EMIs, regardless of how much of the loan you use immediately.

Overdraft Vs Personal Loan

Choosing between a personal loan and an overdraft depends on your financial needs and employment status. If you have a good credit score and need funds for a specific purpose, like buying a house or a car, you can avail of targeted loans for these goals. An unsecured personal loan can be useful for emergency funds.

On the other hand, if you are a sole proprietor or businessperson with a current account, an overdraft might be more suitable for short-term funding needs. It can help you manage the day-to-day financial requirements of your business more effectively.

Conclusion

Choosing between an overdraft and a personal loan in India depends on your financial needs and circumstances. An overdraft offers flexibility and is ideal for managing short-term cash flow issues. At the same time, a personal loan provides a structured repayment plan for larger, defined expenses.

Understanding the differences between these two financial products can help you make an informed decision and select the one that best aligns with your financial goals. Always evaluate your financial situation, compare interest rates, and consider the terms and conditions before applying for an overdraft or a personal loan.