Personal Loan vs Overdraft

Personal loan as well as overdraft account both involve shorter approval process, require minimal documentation and above all both have no compulsions as far as utilisation of funds is concerned. Yet there are considerable differences between the two, in terms of loan structure, borrowing costs and repayment mechanism. There are certain factors that you must keep in mind before deciding whether you should go for a personal loan or for an overdraft facility.

In case of a personal loan, you have to formally apply in a bank or a NBFC and wait for its approval every time you need new funds whereas for an overdraft facility, you have to apply just once and after its approval, you can access funds as many times as you would like without going through any further application process for a long period. Overdraft facility allows you to withdraw money from your current account even after the entire balance in the given account has been exhausted. Based upon your customer profile, a bank puts a cap on the maximum amount that you can borrow from your current account. Both personal loan and overdraft have certain similarities and differences.

Similarities

An overdraft and a personal loan have certain things in common as discussed below:

No Requirement for Collateral

There is no requirement of keeping an asset as collateral for availing a personal loan or an overdraft facility.

Discretion on the Use of Funds

Whether you are borrowing a personal loan or get sanctioned an overdraft facility, you do not need to specify the reason for which you are borrowing the amount. You can use it on your own discretion for any legitimate cause.

Ability to Borrow Small Amounts

Unlike other loans, personal loans and overdraft borrowing facility provides you with an option to borrow amounts as low as Rs. 5,000 from financial institutions.

Easy Accessibility

For an overdraft facility, you do not need to undergo an approval process every time. You can access any amount within the limit prescribed by the bank, instantly. On the other hand, the application process for a personal loan is also very simple and requires minimum documentation and verification. This makes these borrowing options quick and easily accessible.

Differences

There are considerable differences between a personal loan and an overdraft. These are:

Structure of Loan

While a personal loan is an unsecured loan, an overdraft facility can be availed over your current account. A personal loan amount is made available in one go whereas in case of an overdraft, the money can be withdrawn as and when needed provided the overall amount does not exceed the limit prescribed by the bank. Also, the interest is to be paid only on the borrowed amount in case of an overdraft.

Application

While in case of a personal loan, a formal application is to be filed at a financial institution with required documents every single time you need to borrow. After this, a bank verifies the documents, enquires your credit report, calculate your creditworthiness and then decides upon the various lending aspects. However, in case you are already availing an overdraft facility, no such formalities are required, you can withdraw anytime, anywhere at your own will without taking prior permission from the bank.

Lending Amount

The lending amount for a personal loan is set when a mutual consent is reached between both the parties. Therefore, it takes into consideration both- your needs as well as the bank’s will. On the other hand, the limit for borrowing through an overdraft account is solely set by the bank on its own discretion. If you require cash that exceeds the maximum limit prescribed, you will have to look for some other option.

Tenure

Personal loans are fixed term loans with an average duration ranging between 12 to 60 months. However, the duration for the complete repayment of an overdraft is not fixed and they are often repaid in a much shorter duration than a personal loan.

Interest Rate

While a monthly interest is charged on a personal loan, an overdraft charges a daily interest. The interest rates over overdrafts are usually higher than that of a personal loan. Also, the interest is to be paid on the total amount of loan sanctioned in case of a personal loan whereas for an overdraft, interest is to be paid only on the withdrawn amount and not on the overall limit prescribed.

Repayment

A personal loan comes with fixed EMIs for repayment whereas an overdraft can be paid back any time either fully or partially as suitable to you. However, if the bank demands for repayment, you will have to fulfill those demands immediately. In case of prepayment of a personal loan, a bank levies prepayment charges that may range from 1% to as high as 5%. No such charges are associated with an overdraft.

Credit Score

While processing a personal loan application, a bank requests a hard inquiry on your credit report. This may slightly affect your credit report, lowering your credit score. However, no such inquiry is involved in case of borrowing from an overdraft account. Thus, it does not have any affect on your credit score.

Multiplicity

In case of personal loans, you will have to apply for a new loan every time you need money. However, you can borrow as many times as you want over a single overdraft account. You do not need to request for a new account every time.

Which one to Avail?

If you need money for an emergency or for meeting your day-to-day requirements of funds, an overdraft account will be a good option for you as it does not require any kind of application and documentation for accessing the funds. Further, the bank will not take any time to release the funds over an overdraft facility. You can therefore enjoy instant funds with the option of repaying the amount anytime. It is the most suitable option for curbing your temporary unavailability of funds.

However, if you require funds for a long-term investment or expenses, a personal loan is a better option. It will lower down the interest cost in comparison to an overdraft that charges interest on a daily basis. A personal loan also provides the stability of repayment through fixed EMIs and fixed monthly interest rates.

Takeaway

Both personal loan and overdraft facility have their own pros and cons. While the former involves a fixed amount of disbursement and a fixed schedule of repayment, so is the best suitable to the persons who have monthly fixed income while in the latter case, the credit amount as well as the repayment schedule being free from any bondage, best suits the requirement of a self employed person. Therefore, a personal loan proves to be the best option for the salaried persons whereas, overdraft facility being providing flexible repayment best suits for businessmen whose income keeps fluctuating from time-to-time. Therefore, we must keep in mind our need, expenditure and repayment capabilities before choosing any of the two options.

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