Overdraft vs Loan – Difference and Comparison

What is Overdraft?

When there isn’t enough money in an account to cover a transaction or withdrawal, but the bank lets it happen anyway, this is called a “overdraft.” Basically, it is a loan from the bank that is given when a person’s account balance reaches $0. The overdraft lets the account holder keep taking money out of the account even when there isn’t enough money in the account to cover the withdrawal.

When a customer has an overdraft, the bank lets them borrow a certain amount of money. With an overdraft account, a bank pays for payments made by a customer that would otherwise be rejected or, in the case of checks, would bounce and be sent back without being paid. Banks make a lot of money off of the interest and transaction fees they charge for overdrafts. But if an account holder uses their overdraft protection too much and there’s a chance they won’t pay it back, the bank can cancel it on its own.

Depending on what your business needs, a business overdraft could be a convenient and helpful solution for a number of things:

  • It’s a flexible way to get money for your business. The money is there and ready to use whenever you need it.

What is Loan?

The term loan refers to a type of credit vehicle in which a sum of money is lent to another party in exchange for future repayment of the value or principal amount. In many cases, the lender also adds interest or finance charges to the principal value which the borrower must repay in addition to the principal balance.

Loans may be for a specific, one-time amount, or they may be available as an open-ended line of credit up to a specified limit.

When money is needed, a person will borrow it from a bank, a business, the government, or another organization. The borrowers’ loan objective, past financial performance, SSN, and other details may be questioned. The debt-to-income ratio is used by lenders to determine whether a loan can be repaid.

The lender accepts or rejects the application based on creditworthiness. Lenders must provide justification for loan denials. If the application is approved, both parties sign a contract. The borrower must pay interest on any money borrowed from the lender.

Before any money or property is transferred, all parties must agree to the loan’s terms. The loan documents specify whether or not the lender requires collateral. Most loans have maximum interest and repayment terms.

Difference Between Overdraft and Loan

  1. An overdraft lets customers withdraw more than their current account credit, up to a certain amount. A loan is money borrowed for a set period and repaid with interest.
  2. Overdrafts are credit facilities whereas loans are for borrowing money
  3. Overdrafts are temporary, and credit limits prevent borrowing large sums. You may be able to borrow large sums of money for long-term growth in loans.
  4. Interest on the overdraft is calculated daily until the overdraft is fully returned. Loan interest, on the other hand, is calculated monthly while taking the loan amount and period into account.
  5. A loan is better for long-term purchases like new equipment or structures whereas an overdraft is for short-term funding.

Comparison Between Overdraft and Loan

Parameters of ComparisonOverdraftLoan
MeaningLets customers withdraw more than their current account creditIs money borrowed and repaid with interest
What it isCredit facilityBorrowed money
UsageIs used for short-term fundingIs used for long-term purchases like new equipment/investment.
LengthPrevents borrowing in large sumsLarge sums can be borrowed for long term growth
InterestComputed dailyCalculated monthly