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5 Differences Between Loan And Overdraft
Individuals who are looking for borrowing money from the bank will be more interested in understanding the difference between loan and overdraft (OD) and which one is better to avail.
Both terms are used while availing amount from the bank for which interest will be charged depending on the duration.
| BASIC COMPARISON | LOAN | OVERDRAFT |
|---|---|---|
| Short Meaning | The loan refers to the fixed amount of money borrowed for a specified period, against a guarantee, which should be repaid with interest. | Overdraft is an arrangement whereby the customer is authorized to withdraw an amount greater than the balance shown as a credit in the current account, but only up to a certain limit. |
| What is it? | Borrowed capital | Credit facility |
| Source of | Long-term funds | Short-term funds |
| Interest | Charged on loan sanctioned. | Charged on amount overdrawn. |
| Calculation of interest | Monthly basis | Daily basis |
| Repayment | Either on demand or on fixed monthly installments. | Through deposits in the bank account. |
| Is it necessary for someone to hold a bank account to benefit from this service? | No, it is not compulsory. | Yes, he / she must have a current account in the respective bank. |
Many business individuals or current account holders will be looking for OD and loan facility from banks to meet their constant demand. Here are 5 differences between loan and overdraft.
1) An overdraft facility is a credit given to the individual or company on a current account. The amount you withdraw can vary every day based on your requirement. It is similar to a credit card spending. You can borrow as much as you need upto your credit limit.
However, a loan is a fixed amount of capital that is borrowed from the bank for a fixed period with regular repayments.
2) In overdraft, the interest rate is charged only on the overdraft amount borrowed not on the limit of the overdraft facility; whereas in Loan, the interest is charged on the entire amount borrowed, whether or not you have completely utilized it. Note that the interest charged on OD is higher than loans.
3) Usually, an overdraft is availed for the short duration and you cannot borrow large sums due to credit limits. A loan can is taken for a long-term period, say around 3-25 years and you can borrow large sums for expansion purposes based on your capacity.
4)Overdraft is ideal for working capital requirements like day to day fund requirements, but loan makes sense for capital investments like a new machinery or new building.
5) Payment option in overdraft facility will be made in a lump sum and can be closed anytime but your credit limit can change depending on your credit score. It is more flexible in terms of payment, while a loan is paid in Equated Monthly Installments (EMI) and have to be paid within the scheduled time to avoid hampering credit ratings and other financial problems.
Conclusion
Loans are best for planned purchases, where in you can also plan your repayments from your earnings. Overdrafts are best suited for smaller emergency expenses and usual business capital required for inventory or stock maintenance.
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