Personal Loan vs Overdraft Account: Key Differences

Both personal loans and overdraft accounts are the credit facilities offered by financial institutions. Although they serve the similar purpose of arranging money at short notice, personal loans and overdraft accounts are fundamentally different products.

A personal loan is an unsecured loan that a lender offers to the borrower. The borrower must repay the loan amount with interest in the form of regular EMIs over a certain period, say ten or fifteen years. The lender evaluates the borrower’s financial standing, loan repayment capability, previous loan history, CIBIL score, etc., to sanction a suitable amount of personal loan.

An overdraft facility is an arrangement between the individual or entity and the bank. Under this arrangement, a person or entity maintains a current account with the bank.The bank authorises that person or entity to withdraw cash greater than the available balance in the current account to a certain limit. The overdraft limit is usually secured against a financial asset such as a fixed deposit.Therefore, the overdraft limit depends on the size of the fixed deposit as well as the person’s eligibility and relationship with the lender.

• Ease of Availability You would require to undergo a lot of paperwork that includes application and document verification for the purpose of taking a personal loan. Also, you must repeat the process every time you seek a loan.On the other hand, an overdraft facility is usually a one-time process. Once your overdraft account is set up, you can regularly use the overdraft facility unless any modification of terms is required.The entire process of acquiring funds through a personal loan can take anywhere between a few hours to a few days. However, it takes a maximum of one business day to withdraw the amount from an overdraft account.
• Interest Rate The interest rate levied on a personal loan can be lower than an overdraft facility. In the case of personal loans, interest rates are decided while sanctioning the loan amount. However, you won’t need to pay any interest if you don’t withdraw an amount from the overdraft limit.
• Tenure A personal loan is usually taken for a long duration, such as ten to fifteen years or more, during which the borrower pays off the loan in instalments. On the contrary, an overdraft facility is used to withdraw amounts for a relatively much shorter duration.
• Repayment Structure The terms or loan repayment are fixed at the onset of a personal loan. The borrower must repay the loan in EMIs as directed by the lender. If the borrower wants to prematurely close the loan account by paying off the loan in full, then the lender may charge prepayment fees.In the case of an overdraft facility, the customer is free to repay the overdraft drawn at any time without attracting any additional fees.
• Loan Vs Credit Limit After reaching a mutual agreement with the borrower, a lender sanctions the personal loan amount. Once the personal loan is sanctioned, neither party can modify the loan amount.But an overdraft facility is an assigning of credit limit to different overdraft account holders. Therefore, a customer can withdraw any amount from the overdraft account as long as the amount is within the assigned limit.
• Effect on Credit Score Your credit score can fluctuate if you frequently take personal loans. Your credit score might take a further beating if any of your cheques bounce because of unforeseeable circumstances like bank holidays, etc. This can result in difficulty in obtaining loans or credit cards in future.In an overdraft account, you service one overdraft facility regularly, which might boost your credit score.

On comparing the features of overdraft vs personal loan , it can be concluded that an overdraft account facility can be a good option for companies requiring short term liquidity for various purposes such as payment of salary, vendor payment, etc.But individuals may find the personal loan a more viable option as it provides ample time for loan repayment without stretching one’s finances.Go through the features of both a personal loan and an overdraft account and choose the option best suited for you.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.