Money is the primary requirement for any monetary purchase to be made. It can be a business to operate or a family to function; money has played a prime part in everyone’s lives.
The funds are generated naturally by the income made by an individual. The salary that he receives or the revenue earned out of business is utilized in several ways for his requirement.
It can be for his family, it may also be for any purchase, or it can also be for paying wages to his employees. The generated revenue has its way of seeing the expense too.
Banks predominantly came into existence to save money. This benefited people as the money made through businesses those days were deposited in the bank for future use.
With time, the needs and wants of people changed. It changed to such an extent that the demand for money also increased.
It is also to be noted the environmental conditions of the earth, the rate at which people fall sick for chronic sicknesses also has increased. Money is thus required for the treatment too.
What if the requirement for money is more than what the bank balance has? What if the income earned is not sufficient for a specific purchase to be made?
Banks introduced two important schemes for quick money disbursal from the bank’s side, which can be used by the customer and pay back the same to the bank later with minimal interest. One is the Overdraft, and the other is the Term Loan.
Both of them shall assist in improving the financial situation considerably. However, they both are different from one another.
Key Takeaways
- An overdraft is a banking facility that allows account holders to withdraw more money than they have in their account up to a predetermined limit. At the same time, a term loan has a fixed repayment schedule and a specified maturity date.
- Overdrafts are flexible and can be used as needed, with interest charged only on the overdrawn amount. At the same time, term loans provide a lump sum upfront, with fixed repayments over the loan tenure, regardless of how much the loan is used.
- Overdrafts are better suited for short-term cash flow needs and managing working capital, while term loans are more appropriate for larger investments, long-term projects, or significant expenses.
Overdraft vs Term Loan
The difference between Overdraft and Term Loan is the usage, Overdraft is used for operating expense which is on a short-term basis, whereas a Term loan is usually used for a long term and is used to make high-value purchases.
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Comparison Table
| Parameter of Comparison | Overdraft | Term Loan |
|---|---|---|
| Meaning | Overdraft is the extension of credit to withdraw funds even when the account balance is zero. The arrangement made with the bank for the current account is to set a specific limit for withdrawal even after the funds are nil. | A term loan is the funds offered by the bank in advance for a certain period within which it has to be repaid. The duration is fixed in the case of a term loan. |
| Amount Availed | Bank offers less amount through Overdraft. A limit is set, and the money can be withdrawn within the limit as an overdraft. | Usually, the term loans are higher amounts. |
| Rate of Interest | The interest rate for the overdraft amount is usually higher than the term loan interest. | Term loan incurs less rate of interest than overdraft amount. |
| Purpose | Overdraft is usually taken for short-term expenses. | Term loans are availed for the long term and help to make high-value purchases. |
| Duration of settlement | The duration of repayment is significantly less for the overdraft amount. | The duration is usually longer, with fixed repayment dates in instalments. |
What is Overdraft?
Overdraft is a facility offered by the bank for withdrawing funds from the bank account even when the account balance is zero. This facility is offered when the customer makes an arrangement with the bank to set a specific withdrawal limit with an acceptable rate of interest.
In simple words, an overdraft is the extension of credit on the bank account when it reaches zero. This allows the customer to use the funds even if the account has zero balance.
This amount being borrowed will be within the limit that the bank has set for the account. The interest shall be charged for the amount withdrawn, including an overdraft fee.
The overdraft option is usually used for short-term gains and must be paid in a short duration too. The rate of interest through this facility is higher than other money-borrowing options.
The bank offers this service to make any payment, to cover him/her from non-payment. In turn, the interest is charged for the amount used.
The amount availed using Overdraft is less, depending on the bank and the bank account status. This is also a type of loan where the customer gets to pay the interest for the loan availed.
What is Term Loan?
A term Loan is a financial arrangement done by the bank to the customer, which is repaid in regular fixed intervals. A term loan is a monetary loan offered by a bank which lasts between one and ten years.
There are certain term loans which can also last up to 35 years. Term loans are offered to individuals as well as small businesses.
Term loans are usually used for high-value purchases. The rate of interest is not as high as the Overdraft, but it is fixed.
The regular payments are to be made every month as an instalment which includes the interest as well as the principal amount.
It is always advised by that financial experts to confirm if the rate of interest is fixed or floating as the rate of interest may impact future payments if the rates fluctuate.
Another aspect to be noted while taking a term loan is the type of interest. It is advised to check if the interest charged is compounding; if yes, the amount to be paid shall increase in the coming time.
It is also advised to take term loans for a limited period and not very long term. The market’s vulnerability can damage the banking system and economy.
Main Differences Between Overdraft and Term Loans
- The facilities offered by the bank to solve the cash crunch situation are commendable. It is wise to know the differences to choose the best one. The main difference between Overdraft and Term loans is the usage; Overdraft is usually used short-term to address minor cash needs. A term loan is for the long term and is used to purchase high-value items.
- The amount of money the bank offers for both cases also varies; the Overdraft shall help the customer with less money, while term loans are huge.
- The interest banks charge for the Overdraft is always more than the term loan.
- The duration to pay back the overdraft amount is shorter when compared to term loans. The duration of term loans can be up to 35 years.
- Overdraft does not need any new account to be created; normally, a term loan needs a loan account to be created in which the repayments will reflect. The bank automatically creates the loan account once the loan is availed.
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
