What Are The Key Differences Between A Personal Loan & An Overdraft Loan?

Mohan looked at his phone, his fingers poised over the banking app. With his sister’s wedding just 30 days away, unexpected expenses had begun to accumulate: ₹2,00,000 for the venue advance, ₹50,000 for the last-minute decorations, and ₹20,000 for vendor tips. Is it better for him to use personal loans or to acquire an overdraft facility? The decision was challenging.

He recalled his father’s advice about money—“Beta, borrowing is like cooking spices; the right one adds flavour, the wrong one burns the dish.”

A personal loan seemed like a carefully crafted recipe—a set amount, structured repayments, and a clear interest rate. It was perfect for significant expenses, like the venue deposit he needed to cover. On the other hand, an overdraft felt more like adding spices as you cook—quick, flexible, and handy for smaller, unexpected costs, such as last-minute gifts and tips for vendors.

As Mohan explored his options, he began to understand that the choice between personal loans and overdrafts required knowledge beyond simple numbers because it involved finding the right financial tool for various situations.

PERSONAL LOAN: A FIXED AMOUNT FOR YOUR NEEDS

It is an amount of money that people borrow from a bank, credit union, or online lender to use for a variety of purposes. It can be repaid in fixed monthly installments at a fixed interest rate.

HOW DO THEY WORK?

They work like an auto loan, where a lender provides a fixed amount of money to the borrower. And the borrower must repay it with interest over the promised period. 

APPLICATION AND APPROVAL

Mohan needs ₹2,00,000 for his sister's wedding, so he plans to obtain a personal loan through a bank or financial institution. Before approving the loan, the lender will check the applicant's credit score along with their income status, employment situation, and payment history.

LOAN DISBURSEMENT

Mohan receives the total loan amount of his approved application through his bank account. Through the fund’s transfer, Mohan can plan expenses necessary for venue bookings, catering, and decoration among all other expenses.

EMI CALCULATION AND FIXED REPAYMENTS (EMIs)

Mohan must pay back the loan through equal monthly installments (EMIs) during a predefined period of 24 months. Each EMI comprises:

• Principal Amount: It is a part of the total borrowed sum.
• Interest: It is the fee that the lender charges for the loan.

If he took a loan of ₹2,00,000 at 12% per annum for 24 months, his estimated EMI would be close to ₹9,400 per month.

INTEREST RATES AND TENURE

• Fixed or Floating Interest Rates: The majority of personal loans come with fixed interest rates, which provide borrowers with predictable repayment amounts.
  
  

• Loan Tenure: Usually ranges from 12 to 60 months. A longer tenure reduces the EMI amount but increases the total interest paid.

   

NO COLLATERAL NEEDED

Personal loans do not need collateral like home or car loans. For example, Mohan will not have to place property or gold as security. However, he needs to maintain a good credit score of 700 or above to get the loan approved.

CHOOSE FROM PREPAYMENT AND FORECLOSURE OPTIONS

Mohan can prepay or foreclose the loan before the end of the period, saving a good sum in the total interest amount. Such banks would most likely levy a prepayment charge typically varying between 2% to 5% of the outstanding loan.

ADVANTAGES AND DISADVANTAGES OF PERSONAL LOANS

OVERDRAFT LOAN: INSTANT ACCESS TO EXTRA CASH 

It is a kind of short-term credit given by different banks and non-banking financial companies (NBFCs). This type of loan enables individuals to withdraw funds from their bank accounts even if their balance is zero. In Mohan’s case, his overdraft limit might be ₹1,00,000.

Interest is charged on the amount used and is calculated according to the Annual Percentage Rate (APR), and the borrowed amount needs to be repaid within a designated timeframe. 

HOW DO THEY WORK?

FLEXIBILITY IN BORROWING

With an overdraft, you do not need to borrow a fixed amount like a personal loan. If Mohan’s checking account balance is ₹20,000 and he needs ₹50,000 for a wedding vendor, he can access the full ₹50,000 by utilising ₹30,000 of his overdraft limit, leaving him with ₹70,000 in available overdraft credit.

REPAYMENT

It is flexible as you don’t have any fixed monthly payments. Instead, the bank will charge interest only on the amount you use, and usually, the interest rate ranges from 15% to 18% per annum. The longer you keep the balance unpaid, the more you’ll owe.

For example, Mohan will only pay interest on the amount borrowed.

INTEREST AND FEES

Interest is charged either daily or monthly, based on the bank's policies. There could also be fees for going over the limit or for withdrawing funds, which can increase costs over time if not handled properly. If Mohan utilised the entire ₹1,00,000 overdraft for a month at an interest rate of 16%, the monthly interest would be:

ACCESSIBILITY

One of the main benefits is that you can access the overdraft loan whenever you need it, right from your checking account or ATM, without having to go through a formal application process.

PROS AND CONS OF AN OVERDRAFT LOAN

BATTLE OF THE LOANS: KEY DIFFERENCES YOU NEED TO KNOW

WHO CAN QUALIFY FOR THESE LOANS?

PERSONAL LOAN

• AGE: 21-60 years
• INCOME: Steady Income (e.g., ₹25,000+/month)
• CREDIT SCORE: Usually 650 or higher
• EMPLOYMENT: Salaried, Self-employed, or business owners

OVERDRAFT LOAN

• AGE: 18+ years
• ACCOUNT: Must have an active bank account with the lender
• CREDIT HISTORY: Preferably good,  though not always required
• INCOME: Steady income (less strict than personal loan)

FINAL THOUGHTS

Deciding between a personal loan and an overdraft loan hinges on your financial situation. A personal loan is reliable if you want a good amount for a major purchase such as a wedding venue or need to consolidate debt. 

This way, your payments are fixed monthly, with a simple repayment route to follow. If, instead, your needs are more varied, e.g., covering small, unexpected costs such as vendor tips or last-minute purchases, an overdraft allows you to get quick access to money without a repayment schedule but will usually charge much more in interest if it is not paid up promptly.

In Mohan's situation, he might opt for a personal loan to cover larger, planned expenses while using the overdraft loan for smaller, urgent needs as they come up. By grasping the distinctions, benefits, and drawbacks of each option, you can make a well-informed choice that aligns with your financial circumstances and objectives. As his father wisely noted, the right financial tool, much like the right spice, can truly make a difference.

FAQs

Do personal loans charge interest rates at a level below overdraft loans?

Personal loan rates tend to be reduced when compared to the interest rates of overdraft loans.

Can customers simultaneously use personal loans combined with overdraft loans?

Financial conditions and the bank's consent determine whether you can take advantage of personal loans and overdraft loans simultaneously.

Does an overdraft loan result in any credit score damage?

Failure to make your loan payments will damage the rating your credit agencies have assigned to you.

Can I repay my personal loan before the set due date without adverse consequences from the lender?

Your ability to repay your loan early exists with the potential for prepayment penalties from certain lenders.

Does an overdraft loan provide better value than a credit card?

The interest rates for overdraft loans tend to be lower than those of credit cards but the exact rates depend on your usage of the loans.

What is the shortest period to receive approval for personal loans?

Personal loan lenders apply varying processing times that range from a few hours up to several days.

Do overdraft loans need collateral?

Most overdraft loans exist without security; however, specific banks may require asset provision when customers request elevated borrowing capacities.

Can I increase my overdraft limit?

Banks grant limit increases for their accounts based on customers' account activity together with their creditworthiness assessments.

What will happen if I fail to repay the money I borrowed through my bank account?

An overdraft fee will trigger bank penalties, which also damage your credit standing.

Are there any alternatives to personal and overdraft loans?

Different options exist to replace an overdraft, such as credit cards as well as payday loans and lines of credit, yet each has distinctive requirements.

Can self-employed people qualify for personal loans?

Yes, but the person may need to show other proofs of income.

Can an overdraft facility be converted into a personal loan? 

Some banks may offer this option, but it is at their discretion.

Can interest rates be negotiated on a personal loan?

Yes, some lenders are willing to negotiate based on credit profile.

Is it possible to get an overdraft loan scored poorly?

It's a hard ball, yet with the right conversations and goodwill, it can still be managed.

What documents do I need for a personal loan?

Usually, you will require identification proof, income proof, and bank statements.

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LoansJagat Team

We are a team of writers, editors, and proofreaders with 15+ years of experience in the finance field. We are your personal finance gurus! But, we will explain everything in simplified language. Our aim is to make personal and business finance easier for you. While we help you upgrade your financial knowledge, why don't you read some of our blogs?