Overdraft vs personal loan explained: Key benefits, rates and when to choose each
In today’s rapidly changing economic conditions, borrowers are often tempted to choose between personal loans and overdraft facilities to facilitate their liquidity needs.
That is why knowing the key differences between the two is crucial. It will help aspiring borrowers make the right choice based on their individual financial needs, repayment capacity, long-term goals, and aspirations.
Understanding overdraft facilities
An overdraft is a flexible credit line linked to a current or savings account. It permits the account holders to withdraw more money than they have. The sum of money that can be withdrawn is permitted up to a pre-approved limit.
This facility is primarily designed to fill short-term financial gaps. It offers instant access to funds without a lengthy application process. Keep in mind that the interest charged is only on the amount utilised and not the entire credit line. This feature makes it suitable for emergencies or unexpected expenses.
Still, overdrafts generally come with higher interest rates, hovering between 18% and 24% per annum. Further, they may even require collateral in some cases. Given these factors, the risk of overspending is also higher with overdrafts, as the ease of availability can lead to habitual use and potential debt cycles.
Exploring personal loans
A personal loan, on the other hand, provides a lump sum of money upfront, which is repaid by the borrower through fixed monthly payments, i.e., instalments (EMIs) over a set period. These loans are ideal for planned expenses such as renovation of a home, marriages or debt consolidation. Personal loans offer lower interest rates ranging from 8.75% to 24% per annum, along with longer repayment tenures sometimes extending up to seven years or even more.
Saurabh Bansal, founder, Finatwork Investment Advisor, advises people to be careful while borrowing money. He says, “Avoid personal loans for lifestyle or planned spends, they should be a last resort. A genuine case is a medical emergency where insurance or savings fall short. With rising healthcare costs, a loan may be needed. Always check prepayment terms and repay quickly to protect your credit health.”
That is why a structured repayment schedule aids budgeting, and efficient planning defends against falling into unwanted debt. The reason the loan has been taken is crucial. Due to this, borrowers should think this out carefully before applying for any loan product.
Furthermore, it is important to remember that most personal loans do not require collateral. Still, approval can take longer, and prepayment charges may apply if the loan is settled early.
Key differences at a glance
Below are the key differences and features of personal loans and overdrafts at a glance. Borrowers should always consult professionals and make informed decisions before applying for any particular credit line or loan product.
| Feature | Overdraft facility | Personal loan |
|---|---|---|
| Interest rate range | Higher (18-24% p.a.) | Lower (8.75–24% p.a.) |
| Repayment flexibility | Highly flexible | Fixed monthly instalments |
| Loan amount | Lower, up to approved limit | Higher, lump sum disbursed |
| Best for | Short term needs | Planned, long-term expenses |
Note: The comparison above is indicative and may vary across lenders. Always review the terms, interest rates, and conditions before choosing a credit option that suits your needs.
Making the right choice
Hence, choosing between an overdraft and a personal loan depends on the specific financial requirement. Overdrafts are best suited for immediate, short-term funding needs, while personal loans are more appropriate for larger, planned expenses.
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