What's the Difference between Overdraft and Installment Loans?

The answer to this question will be different from person to person. Generally speaking, if someone is looking for a small loan, an overdraft may be a better option for them, while an installment loan may be better for someone who needs a large sum of money at once. So, which one is better? Loan or overdraft?

Key Takeaways

• Overdrafts are ideal for short-term borrowing needs, providing flexibility and quick access to funds.
• Personal loans are designed for specific financial goals, such as debt consolidation or major expenses. They offer a lump sum with fixed monthly repayments, providing structure and predictability.
• Before choosing between an overdraft and a personal loan, individuals should assess their financial situation, goals, and repayment capacity. Overdrafts are beneficial for those with fluctuating cash flow and short-term needs, while personal loans offer structured repayment for specific purposes.

What Is an Overdraft?

An overdraft is a form of a short-term loan allowing an individual to borrow money through their bank account. This is only up to a certain limit, and there is no real set repayment date. Though some overdrafts will be interest-free, most are not, and an individual will be charged interest on whatever amount is borrowed at a variable interest rate. 

Overdrafts should usually only be looked at as a form of short-term credit and not an extension of your funds. 

What Is an Arranged Overdraft?

An arranged overdraft is a pre-agreed upon limit that allows an individual to spend more than they have in their account at that time. This safety net can be used to cover unexpected bills or emergency costs. 

Some banks offer an arranged overdraft free of charge, while others apply charges. 

What Is an Unarranged Overdraft? 

An unarranged overdraft is when someone spends more than they have in their current account and has not created a pre-agreed limit with their bank. 

As of April 2020, banks must apply one interest rate to all overdrafts, whether arranged or unarranged, and must remain consistent. 

How Is an Overdraft Beneficial?

Overdraft borrowing limits are lower than loans, which makes them great for short-term borrowing. When an individual needs a small amount of money for a short period, an overdraft is a much better option than getting a loan. 

What Is the Usual Overdraft Limit?

The limits will depend on many factors, such as the bank account someone has. While some banks offer an overdraft facility, some do not. However, even if a bank does offer it, it is at the bank’s discretion whether they offer it to someone.

When applying for an overdraft, someone’s creditworthiness will be taken into consideration by the bank, as well as their age, earnings, and credit rating. If the bank decides they are an okay fit, they will be offered an overdraft.

Personal Loan vs. Overdraft

Personal loan or overdraft, which should you choose? First, what is the difference between a personal loan and an overdraft? The decision between a personal loan and an overdraft depends on your financial needs and circumstances. If you require immediate access to funds for short-term needs and have a fluctuating cash flow, an overdraft might be suitable.

However, if you have a specific purpose, need a larger sum, and prefer a structured repayment plan, a personal loan could be the better option. Understanding the distinctions helps you make an informed choice based on your unique financial situation.

Is an Overdraft a Personal Loan? Are They the Same?

An overdraft and a personal loan serve very different financial purposes.

• An overdraft, associated with a checking account, allows account holders to withdraw more than their available balance, catering to short-term cash flow gaps. The bank sets a limit for overdrafts, and interest is charged only on the amount overdrawn. Repayment happens when funds are deposited into the account.
• On the other hand, a personal loan offers a lump sum for specific purposes, such as debt consolidation or major expenses, with fixed monthly repayments over a set term.

Unlike overdrafts, personal loans involve interest on the entire loan amount and adhere to a predetermined repayment schedule. Recognizing the disparities between these financial products is crucial for individuals to make informed decisions based on their unique financial needs and goals.

Pros of an Overdraft 

There are a couple of pros to overdrafts, such as the following:

• Money is withdrawn from the account within a couple of hours or within one day of setting up an overdraft account.
• Individuals can take as much money as they need within the bank's limits, paying it back over whatever time they can. This can be days or weeks, or even months.
• No interest accumulates on money an individual has not withdrawn from the limit. This means that there will not be any additional charges.

Cons of an Overdraft

• High-interest rates make borrowing costly.
• Low borrowing limits
• Bank has the ability to reduce the limit or cancel your overdraft at any moment.
• It can be easy to become stuck in your overdraft for long periods of time.

Which Is Better Overdraft or Personal Loan?

Choosing between an overdraft and a personal loan depends on your financial situation. An overdraft is beneficial for those facing short-term cash flow gaps or unexpected expenses, as it provides flexibility with immediate access to additional funds linked to your checking account.

On the other hand, a personal loan is a lump-sum amount borrowed for specific purposes, offering a structured approach with fixed monthly repayments over a set term. Personal loans are ideal for larger expenses or achieving particular financial goals, such as debt consolidation.

To determine which is better for you, consider the nature of your financial requirements. If you anticipate short-term needs and have a fluctuating cash flow, an overdraft might provide the necessary flexibility. However, if you have a specific purpose, need a larger sum, and prefer a clear repayment plan, a personal loan could be the more suitable option. Evaluating your financial goals and preferences will guide you in making the choice that aligns best with your unique situation.

What To Consider Before Applying for an Overdraft

There is a lot to consider before applying for this type of loan, including how often you are going to use it. If you are someone who overspends a lot, you may end up stuck in a never-ending cycle of an overdraft, unable to get yourself out of it. If that happens, you could end up getting it revoked by your bank.  

What Is an Installment Loan?

An installment loan is an agreement that a loan will be repaid over time with a set number of scheduled payments. This is normally month to month, with the payment date on the same day. The term of this loan may be a few months, or it could be as long as 30 years.

An installment loan of any kind may be the most beneficial for you; depending on the amount, they can be used for a wide range of things.

Pros of an Installment Loan

Some pros to an installment loan include:

• Quickly approved. Many people will see the money in their bank accounts within 24 hours of approval.
• Fixed monthly payments make it easier for people to budget for repayments.
• You can borrow a much larger sum of money than you can with an overdraft
• Individuals can usually choose their repayment term, which can be over years to make it more manageable.
• Unlike a car loan, an installment loan can be used for anything an individual needs it for.

Cons of an Installment Loan

• If you miss a repayment, your credit score may be negatively affected since the payments are less flexible than an overdraft. This could be an issue if someone has an income that varies monthly.

What To Consider Before Applying for an Installment Loan

Before applying for an installment loan, you should consider the repayment timeline and monthly payment amounts. See how much a bank is willing to lend you and use an installment loan calculator to determine if you will be able to afford the monthly payments in the term.

Sometimes, it will be better for certain people to concentrate on building their savings for a large purchase instead of taking out a loan

How Do You Apply for a Loan?

Applying for an installment loan is fairly quick and easy. Overdrafts can be applied for by contacting your bank, and installment loans can be applied for, much like a credit card, through the lender’s website.

Typically, lenders will go through a couple of checks before approving an amount for a loan, such as checking someone’s credit score, income, and an assessment on how well the person will pay the loan back. When approved, the loan will be ready soon after.