Personal loans are the most popular method of borrowing money, compared to overdrafts. Choosing the best method of credit can be tricky. Both have their advantages and disadvantages, according to their use. Use this guide to determine which is the best option for you.
What is a personal loan?
A loan is a fixed amount of money that is borrowed over a period that needs to be paid back in monthly instalments after the time ends. This money is borrowed from lenders that also issue an interest rate on the amount you take out, which over time is the lenders’ profit. A personal loan is a loan that can be used for a variety of purposes, from a down payment towards a mortgage to paying for a much-needed vacation. Your approval and loan terms for a personal loan depend on your credit score and credit history.
Terms you need to know to understand personal loans;
- Principal amount: The original amount you borrow from the lender.
- Interest rate: Interest accumulates over time according to this rate which is paid on top of the principal amount. Read more about how personal loan interests are calculated.
- Loan term: The set amount of monthly installments and months that you have to repay the loan.
- Unsecured vs. secured: Personal loans are most often unsecured, meaning you don’t need to have an asset as collateral against your loan.
Advantages of having a personal loan
- A fixed interest rate means that it cannot go up and have you paying more than what you expected.
- A fixed principal amount so that you’re not tempted to overspend.
- Fixed monthly payments making repayment easy.
Disadvantages
- You need to apply for another loan if you need additional funds, as you’re not able to borrow on top of an existing loan.
- Missing payments negatively impact your credit score by lowering it, which can affect future applications.
- There could be expensive repayment charges.
What is an overdraft facility?
An overdraft facility is a credit facility that exists as an attachment to your current transactional account. It functions as an agreement between you and the lender where you are allowed to spend over what is in your bank account. How much overdraft is available is dependent on your bank balance and your income. To have access to an overdraft facility, you will need to open an account with a bank that offers the service. Once you’ve applied and it is approved, the overdraft is always there whenever you need it.
What you need to know to understand overdrafts
- Ease of usage: It is only activated when used, so you can spend more than your available balance.
- Maximum limit: There is a max limit on top of your overdraft facility, which is usually the amount you pay for.
- Repayment method: You repay your overdraft as money comes into your account.
Advantages of using an overdraft facility
- You can’t miss a payment on an overdraft as the money is already available and is being paid for as money comes into your account.
- Unexpected costs can be dealt with immediately with an overdraft once you’ve been approved for it.
- There is no repayment term, so you can pay it back when you can.
Disadvantages
- Overspending is easier to do with an overdraft as the funds are always available.
- Variable interest rates can mean that the interest can increase and thus increase how much you need to pay.
- You need a really good credit score to qualify for an overdraft.
- Because the overdraft facility is connected to your account, negative balances are automatically paid for by money coming in.
- An overdraft offers a lower amount to use than a personal loan.
What is the difference between an overdraft and a personal loan?
Availability
To have access to a personal loan you need to make sure you have a good credit score and credit payment history. Once approved, you have a set amount to use and a certain amount of time to repay. To take out another personal loan, you will need to go through the process again. With an overdraft facility, depending on if your bank account has the service, you apply once and the overdraft stays open for you to use whenever needed.
Interest rate
With a personal loan, your interest rate is pre-determined and added to your loan amount. Overdraft interest rates are usually higher than personal loans. If you don’t withdraw any money from your overdraft, no interest is charged.
Credit limit
When taking out a personal loan, the loan amount is set after agreeing with your lender. After this, loan terms can’t be changed. However, with an overdraft, you’re able to withdraw any amount that you need.
Repayment
An overdraft facility allows you to repay the credit whenever you want as it is always attached to your account. For a personal loan, you agree to repay the loan after a certain time. If you want to repay your loan in full before the loan term is over, you might have to pay pre-payment fees. Repaying the overdraft amount does not incur any extra fees.
Which is the best option?
The answer to this question is almost entirely dependent on why you are needing to use credit. If you find yourself running out of cash by month-end, or needing money to cover an urgent payment; an overdraft facility might be the best option for you. If you need to borrow a larger amount to fund larger expenses, like car repairs or home improvements, a personal loan would be better suited. Using a loan to repay an overdraft facility or the other way around, could leave you with debt that you’re unable to pay. Before choosing either a personal loan or an overdraft, make sure that you are financially stable enough to meet repayment requirements.
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FAQs
Loans are, in essence, borrowed funds. Overdrafts, on the other hand, are simply withdrawals made from your current account. However, the withdrawal is in excess of the balance lying in your account.
Is a personal loan the same as an overdraft? ›
A personal loan is usually a lozen with set payments. It may or may not be backed by a lien on some asset. An overdraft is often granted as a courtesy to a bank customer with good credit. It may be for a small amount of perhaps $1,000 to $3,000.
What is the difference between a loan and an overdraft? ›
An overdraft is a variable amount of borrowing agreed with your bank up to a set limit. A loan is a fixed amount of borrowing over a set term with regular repayments. Overdrafts allow you to borrow money as and when you need it up to a limit agreed between you and the bank.
Is overdraft counted as a personal loan? ›
Summary: A personal loan and a personal overdraft loan are different lending instruments that make your financial life more manageable. While personal loans are apt for salaried individuals with a fixed monthly income, a personal overdraft loan is an overdraft facility that your bank extends to your account.
Why is it better to apply for an overdraft rather than a loan? ›
An overdraft gives you immediate access to extra funds when you don't have any left. Ideal for temporary financial issues, unexpected expenses or emergency costs, an overdraft gives you the comfort of knowing you will always have financial back-up. You only pay interest on what you use.
Which is better an overdraft or a personal loan? ›
The interest rates on an overdraft may be higher than those on a credit card or personal loan, especially for long-term borrowing. Carrying a lot of debt could affect your credit score and your ability to secure further credit in the future. Unlike a personal loan or credit card, there's no structure around repayments.
Can you use a personal loan to pay off overdraft? ›
You should explain your situation and tell them why you're struggling to pay off your overdraft. If you think you're vulnerable you should let your bank know - they have to treat you fairly. If you're struggling to pay, your bank might: offer you a repayment plan this might include a personal loan.
Can you use overdraft as a loan? ›
An overdraft loan allows quick access to a small amount of money to help you cover an overdraw on your account. The loan amount is typically anywhere from $75 to a thousand dollars with applicable interest rates and fees.
What are the benefits of an overdraft loan? ›
Advantages of an overdraft
- An overdraft is flexible - you only borrow what you need at the time which may make it cheaper than a loan.
- It's quick to arrange.
- There is not normally a charge for paying off the overdraft earlier than expected.
Also, the interest on a Credit Card is suitable for daily purchases and to earn rewards on every purchase. However, check your Personal Loan eligibility when you want to make major purchases. Personal Loans help you meet bigger expenses and are a better choice as it offers a longer tenure of up to 5 years.
Personal loan overdraft facility is a credit line facility wherein the personal loan borrowers can withdraw funds from the loan account as per their sanctioned credit limit.
What is an example of an overdraft loan? ›
A bank overdraft is as same as a bank account that can have a negative balance, up to the sanctioned overdraft limit. Example: If your bank account has Rs. 10 lakh in the bank and you withdraw Rs. 12 lakh for business purposes, an overdraft loan is a by-default loan for the extra Rs.
How does a personal overdraft work? ›
How do personal overdrafts work? You have $500 in your account and you need to pay for $1,000 of expenses. You pay your expenses – using your funds of $500 and $500 of your overdraft. Once you receive $1,000 salary payment, you'll have $500 of your own funds left after paying off your $500 overdraft.
What is the main difference between a loan and an overdraft? ›
While an overdraft is also a form of borrowing, it differs from a loan in that it does not entail a fixed amount of money. With an overdraft, you can withdraw more money than your current account balance up to a limit approved by the bank if needed.
Is it a bad idea to get an overdraft? ›
Absolutely. Regularly using an unarranged overdraft can affect your credit rating because it shows potential lenders that you struggle to manage your finances.
What is an overdraft instead of a loan? ›
Personal Loans lock in your interest rate, ensuring stability in your repayment amount throughout the loan term. Overdrafts, conversely, charge interest only on the amount you withdraw, not your entire credit line, making it a cost-effective option for short-term borrowing without the long-term interest commitment.
Can I get a personal loan if my bank account is overdrawn? ›
If you find that you need a loan to make ends meet after an overdraft, you can usually apply for a personal loan with your bank or another financial institution. Lenders may require information about your credit history and credit score in addition to a relationship history with the bank or financial institution.
Is a student overdraft a personal loan? ›
While 0% overdrafts are useful and should help with cash flow issues while you're a student, they're never part of your income. Always remember, an overdraft is a LOAN and must be repaid (its rate will jump eventually after you've graduated).
What is an overdraft in personal finance? ›
An overdraft occurs when you don't have enough money in your account to cover a transaction, but the bank pays the transaction anyway.
