Bank Overdrafts vs. Loans

Loan Vs. Overdraft
OverdraftLoan
An overdraft is low and requires a current account with a certain bank. A loan can be a lump sum and depending on the type, you can get it from your bank or another.
Overdrafts are ideal when you have an emergency and require money fast.Some types of loans take longer to process and aren’t the best option for emergencies. You can use this for long term projects that can wait the processing time.
The longest you can take to pay it back is up to 6 months.Some loans take up to 10 to 15 years to pay back.
No collateral is requested for an overdraft. All you need is an active current account.Depending on the type of loan, you might need some collateral to secure it.
You can opt to pay it back in one lump sum amount or arrange a few repaymentsLoan repayments are made monthly as agreed with the bank for the duration specified. Some banks can penalize you if you pay back the loan before the time elapses.
Some banks offer overdrafts for free while others charge a fixed fee of $30 to $35.Banks charge interest on the loan that you must pay back with the principal amount lent to you.
Comparing Overdrafts and Loans

Overdrafts

An overdraft is a short term loan that you borrow from your bank using a current account. It has a set limit that you agree with the bank before using it. The best time to get an overdraft is when you have an emergency and don’t have enough money on your current account.

Some banks require a request from you to get the overdraft. For others, it’s automatic once you set up an account. Overdrafts either charge a certain fee or interest on the amount borrowed. The good news is, some banks have current accounts that don’t charge any fees. The limit is relatively low but it depends on the arrangement you have with your bank.

The best time to access an overdraft is when your account balance is at zero. The average fee most banks charge is $30 to $35 depending on the type of current account. Cash flow problems can result in unpaid bills or bounced checks. To avoid such inconveniences, you can arrange an overdraft with your bank. Once you access the extra money through your current account, you have the cash flow to handle the emergency.

The money you obtain as an overdraft is accessible through any means you normally use. It can be through the ATM, online banking, Debit card, mobile phone. Always remember to have the limit in mind and know you can pay it back without overstretching your budget. This way, when money comes into your account, you have enough left to handle your daily expenses.

The Royal Bank of Scotland back in 1728 was the first one to offer its customers an overdraft facility. The initial customer to get this overdraft from his bank was William Hogg. He was a merchant who needed more funds to balance his books. This set the precedent for this bank product that many people use up to date.

When getting an overdraft, do not surpass the limit. If you do, most banks will charge you for that. Only the bank that manages your current account can accept to give you an overdraft. Always ensure you maintain your current account without any financial problems. If the bank gets wind of this, your overdraft limit reduces significantly.

Pros of Overdrafts

  1. Depending on your limit, you can decide on the amount to get when requesting an overdraft. This gives you the freedom to manage your payments better.
  2. Some overdrafts don’t have fees attached to them. Choose a current account that doesn’t charge for the overdraft.
  3. It’s the best emergency fund kitty. With a good limit, you are assured of funds in case you need them on short notice.
  4. An overdraft is processed fast. You can have the money in no time and withdraw it through your debit card, ATM, or online banking.

Cons of Overdrafts

  1. Overdrafts have lower limits compared to loan facilities such as personal/unsecured loans.
  2. Exceeding the limit of an overdraft incurs more costs in terms of extra fees charged.
  3. Some banks still charge a fee of between $30 and $35 on overdraft even within the agreed limit.
  4. The repayment period for an overdraft is short.

Loans

A loan is a fixed amount of money you get from a bank and is paid back with interest. Once you arrange a loan, you must pay it back in the agreed timeframe. There are different types of loans offered to customers by banks. These loans serve different purposes and come with various attached terms and conditions.

Each loan comes with an interest rate and fees attached to it. These are the main sources of income for most banks. To secure some types you need collateral and others like personal loans don’t require security. Different types of loans you can come across include:

  1. Unsecured loans
  2. Secured loans
  3. Close-ended loans
  4. Open-ended loans
  5. Conforming loans
  6. Non-conforming loans

Every bank has certain offers around each type of loan it offers. It costs nothing to shop around before you can pick out one to apply for.

Pros of Loans

  • Depending on the type of loan, you can access more money to use for bigger purposes or projects.
  • Loans have a longer repayment period but vary depending on the type you require.
  • With a good credit score and history, you can get lower interest rates and a longer repayment period.
  • Loans come in multiple types making it easy to pinpoint the one that suits your needs.

Cons

  • Accrues interest.
  • In most cases, a collateral is necessary.

Think of an overdraft when you have a current account and need some money fast. It’s easy to process even though the limit set is lower than that of a loan. Loans come in various types with just as diverse requirements for each. Before applying for one, know its purpose and how to pay it back.