When you need money, you can choose from credit options like personal loans or overdrafts. The choice between the two can be based on how long you need the money, how the interest will be charged, how you will make the payments, etc. So, let us discuss what is a personal loan and overdraft, what is the difference between them and which one is better for you.
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What is a personal loan?
A personal loan is an unsecured loan in which the bank lends you a fixed amount at a fixed interest rate for a fixed period. You have to pay a fixed EMI on a fixed date every month. A personal loan does not offer any flexibility for EMI repayment in terms of the amount to be paid and the date to be paid.
If you pay the outstanding amount before the original tenure, the bank may charge you a penalty. Also, you have to pay interest on the entire principal amount, whether you use the amount or not.
What is an overdraft?
Overdraft is a credit line provided by the bank for a specified limit at a specified interest for a specified period. You have the facility to withdraw the amount from the sanctioned limit whenever you want. Additionally, you also have the facility to repay the amount whenever you want. Interest is charged on the amount used and the number of days used. There is no penalty on prepayment.
Difference between personal loan and overdraft
Now that we understand the basics of personal loans and overdrafts, let’s learn their differences.
| Specialty | personal loan | overdraft |
| loan amount | A fixed loan amount is paid to you in a lump sum. | A certain limit is sanctioned to you, and you can withdraw the amount as per your requirement. |
| interest calculation | In a personal loan, the interest amount is calculated on a monthly basis. | In overdraft, the interest amount is calculated on a daily basis based on the amount used and the number of days used. |
| Return | The borrower has to pay a specified EMI on a fixed date every month. The EMI repayment schedule is specified at the time of giving the loan. | The borrower has the flexibility to make payments whenever he wants. They will have to deposit the amount only in an overdraft account. There is no fixed repayment schedule. |
| credit period | Personal loans are generally more suitable for medium-term tenures of two to five years. | Overdrafts are usually more suitable for short-term periods of up to one year. |
Personal Loan or Overdraft: Which is Better for You?
In the above section, we have discussed the difference between personal loans and overdraft. So, how do you decide whether a personal loan or overdraft is better for you? Well, it depends on the situation. Let’s discuss some scenarios and which one you should choose in each scenario.
The loan amount is known in advance: A personal loan is suitable for a person who knows exactly how much amount he requires and what tenure he requires. For example, if you want to renovate your house for which you have already received quotations, you can opt for a personal loan. Similarly, if you want to buy a mobile, laptop, or consumer durable and already know the price, you can opt for a personal loan.
On the other hand, if you need money but are not sure about the exact amount, you can opt for an overdraft. For example, if there is a medical emergency, and you are not sure what the hospitalization and post-hospitalization expenses are, you can opt for an overdraft. In such a situation, you can withdraw the amount as per your need.
Monthly cash flow and repayment capacity are known in advance: If you are a salaried individual and have a fixed monthly cash flow and you know how much money you can repay as EMI, you can opt for a personal loan. On the other hand, for self-employed individuals, monthly cash flow is uneven. In such a scenario, they are not sure whether they will be able to pay a specified EMI every month or not. Therefore, they can opt for an overdraft.
Are you an impulsive spender?
Some people are compulsive spenders and buy things they may or may not need. When they buy things they don’t need on high-cost loans, they pay high interest on it. If you are one of such impulsive spenders, you can take a personal loan for a specified amount. In such a scenario, you will not be able to spend more than the personal loan amount disbursed by you.
On the other hand, if you are a conscious spender and are prudent about only need-based spending, you can opt for an overdraft. Judicious use of borrowed money can help you avoid high-cost debt.
In conclusion, choosing between a personal loan and an overdraft depends on the situation. Consider factors such as whether you know how much amount you need, your monthly cash flow, repayment capacity, whether are you an impulsive spender, etc. After evaluating these factors, it will be clear to you whether a personal loan or overdraft is better for you. You.