Difference between Bank Overdraft and Bank Loan

Bank Overdraft

A bank overdraft is a credit facility where the current bank account holder is eligible to withdraw excess money over the amount present in their current bank account. It can be viewed as a short-term loan where the holder of a current bank account is entitled to take out excess money in case there is a need for it. The limit up to which the overdraft can be availed off is already agreed upon between the account holder and the bank. However, the bank has every right to alter the limit of overdraft based on certain factors. The overdraft facility is especially popular among businesses who need it to manage their day to day expenses. It is a prime source of working capital for companies from different sectors. Banks and financial institutions also promote the overdraft facility heavily among businesses as it is an important revenue stream for them.

Bank Loan

On the other hand, a bank loan is defined as borrowed capital that any financial institution decided to lend to either an individual or an organisation. This amount is lent for a specific purpose and has to be repaid over a period of time. It is important to note that a bank loan is a long-term liability for the institution. When it comes to the individual, the loan amount might be short-term or long-term based on the time period taken for repayment. Bank loans are a need both for individuals and organisations as it serves multiple purposes. Individuals need it for housing and other personal needs, while businesses depend on it for managing their long-term capital needs. Almost every major company in the country depends on some form of business loan to sustain their operations.

Difference between Bank Overdraft and Bank Loan

Both overdraft and loan are credit facilities that are important not just for individuals or institutions but also for the entire economy. It ensures a proper flow of capital that is necessary to maintain industrial growth in the country. Some of the major points of difference between bank overdraft and bank loan are as follows:

Bank Overdraft

Bank Loan

Definition

A bank overdraft is a credit facility where the current bank account holder is eligible to withdraw excess money over the amount present in their current bank account.

A bank loan is borrowed capital that any financial institution lends to either an individual or an organisation. This amount is lent for a specific purpose, and it has to be repaid over a period of time.

Purpose

The bank overdraft facility is applicable for current account holders as it helps them to finance their daily business operations. It also helps individuals and businesses cover the emergency expenses, pay wages and salaries to staff, issue payments to clear off their debts and also make bill payments.

The bank loan facility helps to facilitate capital purchases for the borrower. These include purchases on assets for businesses or individuals, commencement and setting up a business or upgradation. These loans cannot be used for the purposes of covering the payroll of staff, unlike overdrafts.

Security Requirements

Anyone who is seeking a bank overdraft must know that the bank does not require any security or collateral from the current bank account holder. The only requirement is that the individual or business must have a current bank account with the same bank from where they are seeking the overdraft facility.

Unlike the overdraft facility, a bank loan requires some sort of security or collateral against it. The collateral should also be acceptable to the bank. Notably, the companies have the facility of approaching several banks or financial institutions for a loan. There is no requirement of having a current bank account with the bank from which the borrower wants to take a loan.

Repayment

The repayments for an overdraft is different from that of a loan. This repayment is possible when the company or individual who has taken the overdraft facility gets the money required for repayment. It is important to note that the interest rates for an overdraft are higher than a bank loan.

Loan repayment is made through regular monthly instalments. The interest on the loan is computed by using a formula that includes the principal amount, interest rate and duration in which the loan amount will get paid. The monthly instalment is computed by dividing the overall payable amount by the stipulated payment duration.

Time Duration

The bank overdraft facility is given to individuals and businesses for the purpose of short-term borrowing, and the repayment is generally made between a few days to six months.

The time duration for bank loans is much longer compared to overdrafts. Banks provide loans with repayment periods of up to twenty years.

Bank Account

It is necessary to hold a bank account to avail of the overdraft facility.

It is not necessary to hold a bank account to avail of the loan facility.

Conclusion

There are important differences between overdraft and loan, but both of them are important sources of revenue for banks and financial institutions. Their entire business model is heavily dependent on these two financial instruments. However, banks need to perform due diligence before offering these facilities to make sure that the scope for default on these financial instruments is very low.

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