Overdraft vs Personal Loan

Overdraft vs Personal-Loan: A comprehensive guide to the comparative features

Updated On: November 06, 2024
8 min, Read

In an unpredictable and fast life scenario nowadays, a sudden exigency or an unforeseen natural calamity could throw you a curve and lead to financial liabilities that may be difficult to meet. If you have an emergency fund, you may find it easier to deal with such unexpected expenses. But despite a contingency reserve, the need of the hour may surpass your liquid fund available. It is during such unforeseen circumstances that we understand the importance of various credit facilities available in the financial domain nowadays.

Of the many credit facilities you can avail, two of the most immediately available options are personal loans and overdrafts. The key to figuring out which of these two credit facilities better suits you and your circumstances, is to understand the difference and features that they offer. A common misconception is that personal loans and overdrafts mean the same thing. Well, actually, they’re quite different. Let’s read to get a hang of both of them.

What is an overdraft?

When you hold a current account in a bank, you can withdraw only as much amount you have in the account balance. However, when the account holder is allowed to withdraw cash more than the balance remaining in their current account, it means that you are availing an overdraft facility. Of course, the account holder (can be individuals and companies) can withdraw only up to a certain predetermined credit limit and the bank will charge an interest on the overdraft amount (i.e. the excess amount withdrawn).

An overdraft is a short-term credit facility and are generally secured by the total fixed deposits that an account owner holds with the bank or the financial institution. The credit limit (basically the excess amount that you can borrow via overdraft facility) is normally fixed as a percentage of the amount in the FD.

What is a personal loan?

A personal loan refers to a specific amount at a decided interest rate for a fixed period. It is a type of unsecured loan in which the bank lends you money and you have to pay it back with a specified EMI usually on a fixed date every month. A personal loan doesn't provide any leeway for EMI repayment in terms of the amount to be paid and the date on which it can be paid. If you prepay the outstanding amount before the original tenure, the bank levies a penalty on foreclosure of the loan account. Also, an important thing to know is that you have to pay interest on the entire principal amount, irrespective of the fact whether you use the amount in full or not.

The key differences between a personal loan and an overdraft

Now that we have understood what a personal loan and an overdraft mean, we should now delve a little deeper to know the differences between the two. Here is an overview of how a personal loan and an overdraft vary from each other.

Calculation of interest: When you take a personal loan from a bank or a financial lender, the interest is calculated on a monthly basis. However, for an overdraft facility, the interest calculation is typically done on a daily basis.
Type of credit: Personal loans are basically borrowed funds. Overdrafts, on the other hand, are cash withdrawals made from your current account. However, the withdrawal is more than the actual balance lying in your account.
Time duration: If you want to cover for a longer term, then personal loans are typically more suitable. The repayment tenure can range from 5 years to 20 years or more. On the other hand, the overdraft option preferred for those who are looking for a short-term credit facility who want to meet a short-term fund requirement.
Repayment mode & method:If you avail of funds by applying for a personal loan, you will be expected to repay it via equated monthly instalments or EMIs to be paid on a fixed date. An overdraft, on the other hand, is to be repaid by simply depositing funds into your bank account.
Disbursal of funds:The disbursement of funds is usually longer in the case of a loan. Although the time taken for this has shortened considerably in over the years now, banks still need to verify the application and approve it after submitting detailed documents. But to get an overdraft facility, you can easily get access to required funds within a few hours usually.
Avail tax benefits: Overdraft facilities absolutely don’t offer any tax savings. However, in case of certain loans like home loan, education loan, etc., you can enjoy tax benefits on the EMIs paid over the financial year.