Home >Money >Personal-finance >The difference between an overdraft facility and a personal loan

In order to make bank accounts under the Pradhan Mantri Jan Dhan Yojana, called the Jan Dhan accounts, more attractive, the government recently announced that their overdraft facility will be doubled from 5,000 to 10,000. While most people know about personal loans and credit cards, few are aware about an overdraft facility.

What is it?

The overdraft, when availed, is a short-term loan. The facility allows account holders to make withdrawals from an existing savings bank account even after the balance reaches zero. In other words, if you have an approved overdraft limit of 50,000 and have 1 lakh in your account at present, you can withdraw up to 1.5 lakh.

Some banks offer overdraft facility to salary account customers, based on the employer as well as individual credit profile, or to customers with a sound credit profile. Banks also provide overdraft on a collateral like a fixed deposit. In case of an FD-backed overdraft, the approved limit is lower than the FD value and the interest rate is higher than the FD rate. It is also available against home loans. 

The interest rate applicable could be comparable or higher than personal loan rates for an individual. Repayment is usually allowed over a fixed period of time based on eligibility, and can be in the form of EMIs. You can also repay the entire amount, without any pre-closure charges. 

How is it different?

When you apply for a personal loan and it is approved and disbursed by the bank, the amount is credited to your account. Once the amount is disbursed, the levy of interest starts immediately on the entire amount. For instance, if you take a 50,000 personal loan, irrespective of whether you use the amount or not, you will have to pay interest on the entire sum, until you repay the loan. 

In case of an overdraft, you don’t have to pay interest until you actually withdraw the amount. Moreover, interest is charged only on the amount being used, and not on the entire limit, like in a credit card. For instance, if you have an overdraft limit of 50,000, but you withdraw only 25,000 using the overdraft facility, the interest will be applicable only on 25,000 and not on the entire sum of 50,000. But unlike a credit card, where you have the grace period, when interest is not applicable on the amount borrowed, in an overdraft, interest is applicable from the day of borrowing itself. 

However, the amount allowed to be withdrawn through an overdraft could be lower for a person eligible for a higher personal loan

An overdraft can be used for short-term requirements. If you are using an overdraft but feel you would need more funds or more time to repay, it is a better idea to convert the overdraft into a personal loan.

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