Which is the Better Loan – Term Loan or Overdraft?

Term Loan:

The name “Term” itself means that the loan is for a predefined period as opted by the customer before disbursement where the sanctioned/requested amount is disbursed to the customer’s registered bank account.
There are multiple loan offerings such as Personal Loan, Business Loan, etc. that opt for the same principle. However, the EMI computation varies with the nature of loan type.
To give you an illustration and for simplicity, let’s take an example of a scenario where the need of the user is to utilize the entire sanctioned amount at a time and the principal amount and interest is repaid in regular EMIs over the defined period. This is a classic example of Term Loan conventionally known as a Personal Loan, Auto Loan, Business Loan, etc. depending on the purpose of its end use.

Overdraft :

On the other hand, an Overdraft facility provides a pre-approved credit line for a defined period, here the user has the flexibility to request for disbursement within the sanctioned limit and period as per need and repay whenever borrower has surplus or availability of funds, the interest will be calculated only on the amount utilised and not on the entire credit line.

Term Loan Vs Overdraft : Which is Better?

Now, which is a better term loan or overdraft? Let us simplify this by highlighting the key features of these products:

Overdraft – Drop lineOverdraft – Straight lineTerm LoanFeatures
Subsequent disbursements on requestSubsequent disbursements on requestOne-time disbursementDisbursement
Consists of interest on the utilized amountConsists of interest on the utilized amountConsists of principal and interest of the disbursed amountEMI
Generally, there is no part-prepayment charges but depends on the lenderGenerally, there is no part-prepayment charges but depends on the lenderMay be chargeable, depending on the lenderPart-prepayment Charges
Keeps on dropping with tenureAvailable for the sanctioned period100% utilized at the time of disbursementCredit limit
If you need funds for a longer tenure with higher limit and at the same time wants to minimize the interest amountIf your fund requirement is irregular short term but you want to have a cushion of a credit line.If you are aware of the end use and do not want to manage the EMI calculation like ODBest Used For
Best use case is for the MSME segment.Suitable for individuals to manage day-to-day lifestyle needs and looking for flexible options to repay.If you are aware of the end use and do not want to manage the EMI calculation like ODBest Used For

Types of Overdrafts

To explore more on Overdraft (OD), let us explain the variants of OD that are generally offered by the lenders:

Straight-line Overdraft:

This product is for someone who wants to maintain a day-to-day lifestyle with unpredictable needs and doesn’t want to have the burden of bigger EMIs. The best part of this product is that you have flexibility to repay whenever you have the funds available, and the interest is calculated only on the utilised amount and not on the entire sanctioned limit. The EMI will be the interest computed on the utilised amount. The interest will be applicable if the principal remains unpaid. The payment of the principal amount can be done at the borrower’s will if the interest is being paid.

Illustration: Imagine you got a sanctioned limit of Rs 2 lakh for 12 months; you withdrew 1 lakh on 6th month and before 8th month you repay 1 lakh. The EMI will be computed only on the interest amount applicable on Rs 1 lakh. The credit line of 2 lakh remains sanctioned for you for the remaining period. Before the end of the term of 1 year, you need to pay back the principal and interest.

Drop-line Overdraft:

Unlike straight line OD, this product is generally opted for longer tenure and for high credit value, here the user has the same flexibility of utilizing the amount from the pre-approved credit line, but the difference lies on the credit limit where the available credit line keeps on dropping after every tenure. During the tenure period, the interest gets calculated only on the withdrawn amount and the EMI consists of both principal and interest.

Illustration: Taking the same above example, for a sanctioned limit of Rs 2 lakh for 12 months, the available credit limit will keep on dropping after subsequent tenure proportionally and on 12th month the available limit will be 0. For a sanctioned limit of Rs 2 lakh for 12 months, you can withdraw 1 lakh on the 6th month as the line keeps on dropping. You can repay anytime you wish but the EMI will consist of principal and interest for the utilized period.

Types of Term Loan

Term loans are classified based on their loan tenure. There are mainly three types of term loans, short-term loans, medium-term loans, and long-term loans.

  • Short-term loans: These loans can be availed of for 1-2 years, as the name suggests. The funds can be used for covering day-to-day expenses, and for fulfilling working capital requirement. However, these loans come with a slightly higher rate of interest as compared to medium and long-term loans.
  • Medium-term loans: Medium-terms loans are given to borrowers for a tenure up to 2-5 years. The documents required for these loans are comparatively simpler than long-term loans. The interest rate is also comparatively higher.
  • Long-term loans: These loans are unsecured and are offered for a tenure more than 5 years. These loans come with flexible repayment options and the rate of interest in lower.



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