What is the Difference Between a Loan and an Overdraft?
Last Updated : May 30, 2020, 12:27 p.m.
There can be times when you don’t have the savings to meet your financial needs. There is only one way to get out of such emergencies – by borrowing money to fix these emergencies whether they are personal or business-related. And when you look at the options to get the money, there’s more than one at your disposal. Many banks and financial institutions provide you money for your different financial needs. A Loan and an Overdraft are two of the finance options that many opt for.
But most people don’t know the difference between a loan and an overdraft. Both these finance options look quite similar, and that’s why people get confused between the two. But there are many factors that can help you differentiate the two. In this article, we will be telling you the difference between a loan and an overdraft so that you can choose the suitable one according to your requirement. So, if you are also among those who are looking to borrow some money for your needs but don’t know which to choose – a loan or an overdraft – as you are confused between the two, this article is for you!
What is a Loan and an Overdraft?
Before knowing the difference between a loan and an overdraft, it is important to know what exactly they are. So first, we will be telling you about what is a loan and what is an overdraft.
A loan is a kind of a fixed agreement between a lender, which can be a bank or a Non-banking Financial Company, and the borrower via which the lender disburses the required money to the borrower’s account with the condition that the borrower will repay it within a fixed period along with the interest. The money is known as the loan amount and the period over which you need to repay is known as the loan tenure. There are mainly two types of loans that you can opt for — Secured and Unsecured Loans. Loans that require you to submit security are known as secured loans such as Gold Loan , Home Loan , Loan Against Fixed Deposits . For unsecured loans, you don’t need to submit any kind of security to the lender. A personal loan is one such unsecured loan.
When we talk about the overdraft facility , it is kind of a credit facility by which an individual has the freedom to withdraw the amount from his current account over and above the current balance, upto a certain limit. The credit limit will be fixed by the lender and that tends to change for one individual to another according to their overall profile and Credit Score . An overdraft facility is also known as the Revolving Line of Credit as you can keep withdrawing and depositing the amount back in your account to keep your credit limit as before. So, this is the basic idea about a loan and an overdraft facility.
Factors Differentiating a Loan and an Overdraft
Now you know about the basic introduction about both of these finance options, you must know about some of the important factors based on which you can see how these two are different from each other. All of them are mentioned below. Have a look!
Amount
In the case of a loan, any lender will provide you a fixed loan amount for a fixed period, whereas in the case of an overdraft facility, your credit limit keeps getting renewed as you pay the used amount back. Let’s understand through this an example. Suppose you opt for a personal loan of INR 2 lakh for 5 years. So, this is the amount you get over 2 years. While, if you get an overdraft limit of INR 50,000 on your account, your credit limit will keep getting renewed every time you deposit the amount back after withdrawing the amount. You must remember that amount allowed to be withdrawn via Overdraft Facility will be lower than the amount an individual can get via a loan.
Interest Rates
While availing any financial option, interest rate plays a crucial role as it sets the pace of repayment. If you opt for a loan, the interest will be charged on the whole loan amount, whereas, in the overdraft facility, you will not have to pay any interest amount if you don’t withdraw any amount.
For example, in the case of a personal loan of INR 3,50,000, the interest will be charged on the total amount whether you have used this amount or not. However, if you have an overdraft facility of INR 80,000 and you withdraw only INR 40,000, the interest will be charged only on the withdrawn amount of INR 40,000 and not on the total amount of INR 80,000. But you need to remember that the interest will be charged from the very day you withdraw this amount. So, if you pay this amount on the 20th day since you withdrew it, the interest will be charged for these 20 days only.
Tenure
An overdraft facility is usually suitable for short-term financial requirements as the tenure of this facility is shorter than a loan facility. On the other hand, a loan is used for getting long-term finances and helps in acquiring various fixed assets like land, vehicle, and many other things. The tenure of a loan tends to change according to the loan you are opting for. For example, a personal loan can be taken for a maximum of 5 years, a home loan can be upto a maximum of 30 years, and a new car loan can be a maximum of 7 years. The repayment period can be chosen according to your convenience and repayment capacity.
Coming to the tenure of an overdraft facility, a lender usually gives this to an individual for 1 year. After this period, the lender checks your repayment track and on finding it satisfactory, the tenure of an overdraft facility can be extended further. The tenure of an overdraft facility is usually decided by the lender, so you must keep this in mind.
Calculation of Interest
You must know this fact that when you opt for an overdraft facility then the interest will be charged on the withdrawn amount on a daily basis. It means that if you are repaying the amount after 45 days, the interest will be charged for that time only. Whereas, in the case of a loan, the interest will be calculated on a monthly basis. So, this is one of the major differences between a loan and an overdraft.
Repayment Methods
When you opt for any kind of loan, the repayment can be done by equated monthly installments (EMI) where you have to pay this amount every month on a fixed date. This amount will have a part of the principal amount and a part of the interest amount. If you fail to pay the amount on a fixed date, your credit score can get affected.
Whereas, in the case of overdraft repayment, you can make a lump sum payment that means you can deposit the amount in one go into your account. Also, by doing this, your credit limit will be renewed. Suppose your credit limit is INR 50,000 and you have withdrawn INR 30,000. So when you will deposit this amount with the interest for the days you utilized this amount, your credit limit will be back to INR 50,000.
Other than that, if you want to have an overdraft facility, it is important that you must have an account in the bank from which you want to open this facility. Whereas, you don’t need to have an account to get the personal loan from the lender. The loan amount will be disbursed directly into your account.
So, by now, you must have a fair idea about the differences between a loan and an overdraft facility. Knowing these differences will only help you choose the right alternative.