What is Overdraft?
The Royal Bank of Scotland was the first to introduce the overdraft facility in 1728. It is the authority to withdraw money from a bank up to a specific limit, even if the bank balance is zero. The institution which covers the withdrawn amount is a bank, and the customer benefits from it and has to pay back with interest on the amount used. This type of loan has a fixed amount and is taken for a short time.
Overdraft is beneficiary in emergencies as it allows the customer to withdraw money if the bank balance is low or zero. Regardless, it is a short-term option, and availing of this service requires a prior contract between the customer and the bank. Receiving these short-term funds does not require security or collateral (security money to be forfeited in case of default).
Overdraft permits the loan to be taken at any time, which is beneficial for business in case of loss. But this is only worthwhile if the amount is small, as the interest rate would be higher for more significant amounts. Overdrafts also include a lot of fees and overcharges because, for extending an overdraft, arrangement fees are also required.
What is Term Loan?
Term loan refers to the amount of money borrowed for a specific period. This amount is borrowed from banks and has to be returned within a specific time. They have various types, including short-term loans (a year), intermediate-term loans (for 18 months), and long-term loans (from 3 to 25 years). The term loan can be traced back to ancient Mesopotamia, about 3000 BC when food was used to pay their debts.
The loan is a large amount borrowed for more extended periods for the expansion of businesses and for fulfilling capital requirements such as payment of bills. The interest on these pre-planned funds is charged on the entire borrowed amount regardless of the actual amount used. The interest amount fluctuates, and the repayment is made via monthly installments or on demand.
The loan has to be paid back to the bank monthly, which does not become a burden for the customer. But the monthly recalculation of the interest rate causes fluctuation in the amount being paid back and causes difficulties for the customer. Moreover, the person availing of this service does not have the option to modify the borrowed amount.
Difference Between Overdraft and Term Loan
- Overdraft was first introduced in Scotland, whereas the term loan can be traced back to ancient Mesopotamia.
- Overdraft authorizes money to withdraw in case of a low bank balance, whereas a loan is a fixed amount borrowed for a specific time.
- In an overdraft, the interest rate is calculated only on the amount used, whereas the interest rate is calculated on the entire amount in a loan.
- The overdraft amount can be modified, whereas the loan amount cannot be modified.
- Overdraft is a short-term loan, whereas a loan is long-term.
Comparison Between Overdraft and Term Loan
| Parameters of Comparison | Overdraft | Term Loan |
| History | The Royal Bank of Scotland in 1728 | Ancient Mesopotamia About 3000 BC |
| Term | Short-term Loan | Long-term Loan |
| Interest | Calculated Once | Calculated Monthly |
| Collateral | Not Required | Required |
| Limit | Different for Every Customer and Can be Modified | Specific Amount for a Limited Time and Cannot be Modified |