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.
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.
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.