Money is the primary requirement for any monetary purchase to be done. It can be a business to operate or a family to function, money has made 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 to see the expense too.
Banks predominantly came into existence for saving the 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 need 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 of money is more than what the bank balance has? What if the income earned is not sufficient for a certain 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 at a later period with minimal interest. One is called the Overdraft and the other is called the Term Loan.
Both of them shall assist in improving the financial situation considerably. However, they both are different from one another.
Overdraft vs Term Loan
The main difference between Overdraft and Term Loan is the usage, Overdraft is used for operating expense which is on short term basis whereas Term loan is usually used for a long term and it is used to make high-value purchases.
Comparison Table Between Overdraft and Term Loan (in Tabular Form)
| 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 to set a certain 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 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 A limit is set and the money can be withdrawn within the limit as an overdraft.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 | Rate of interest for overdraft amount is usually higher than the term loan interests. | 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 very less for 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 an arrangement is made with the bank by the customer to set a certain limit of withdrawal 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 and it also includes an overdraft fee.
Overdraft option is usually used for short term gains and it must be paid in short duration too. The rate of interest through this facility is on the higher note 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 and it depends 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?
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 the 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 installment which includes the interest as well as the principal amount.
It is always advised by the 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 are fluctuating.
Another aspect to be noted while taking a term loan is about the type of interest. It is advised to check if the interest charged is compounding, if yes then the amount to be paid shall get increased in the time to come. It is also advised to take term loans for a limited period and not very long term. The vulnerability of the market can do any damage to the banking system and economy.
Main Differences Between Overdraft and Term Loan
- The facilities offered by the bank to solve the cash crunch situations are commendable. It is wise to know the differences to choose the best one. The main difference between Overdraft and Term loan is the usage, Overdraft is usually used in a short term basis to address minor cash needs. A term loan is for the long term and also used to purchase high-value items.
- The amount of money offered by the bank for both the cases also varies, the overdraft shall help the customer with less amount of money while term loans are huge in sum.
- The interest charged by the banks for the overdraft is always more than the term loan.
- The duration to payback 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 term loan needs a loan account to be created in which the repayments will reflect. The loan account is automatically created by the bank once the loan is availed.
Conclusion
The usage of funds for the right cause is always commendable. Loans and Overdrafts can cause havoc for mental stability. Money management technique is required for future well being. The banks have such amazing facilities for the customers.
The customers must choose which is required and which is not. As such, it is clear that overdraft cannot guarantee more money but can manage the unforeseen expense. The term loans can be investments at times if channelled properly.
The bank’s support shall remain forever if the debts are cleared on time without any reminders. If not paid on time, additional fees and credit score impact can happen.
References
- https://www.nber.org/papers/w17028.pdf
- https://www.jstor.org/stable/3520305