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Overdraft or loan?

It can be a challenge deciding whether an overdraft or loan is the best way to borrow based on your personal requirements. An authorised overdraft offers quick access to money for short-term borrowing. A loan can include more competitive interest rates and is more suited to long-term borrowing and higher sums of money. Find out more below.

What are the main differences between an overdraft vs a personal loan? Our guide helps you find the best solution for your personal circumstances. As both loans and overdrafts are forms of debt, it’s important to remember to keep on top of your finances to avoid getting deeper in debt.

What is an overdraft?

An overdraft refers to the agreed borrowing of money once your bank account is empty. In effect, an overdraft is a type of loan and is a form of debt. This means you will have to repay the amount owed to the bank along with interest.

There are two types of overdraft:

As of April 2020, banks are no longer allowed to charge higher fees for unauthorised overdrafts. The interest on your overdraft will be calculated as a single annual interest rate (APR). This makes it easier to compare charges between accounts.

Who is an overdraft suitable for?

As an overdraft is a form of debt, it’s wise to avoid it where possible. Overdrafts are best suited to emergencies and short-term borrowing. For example, an overdraft could be used to pay for unexpected costs such as a bill for home or car repairs.

Overdraft advantages

Authorised overdrafts offer some advantages over a standard loan.

Overdraft disadvantages

As with all forms of debt, it’s important to consider the disadvantages.

What is a loan?

A loan is an agreed transfer of money between a lender and a borrower. The borrower must also agree to pay off the loan over a pre-agreed length of time. This could be used to cover a big purchase or help access the funds to pay off or consolidate other debt.

The two most common types of loan are unsecured and secured loans.

With a secured loan, the borrowed money is secured against an asset such as your home. In this case, failure to make repayments may result in the repossession of your home.

An unsecured loan, or personal loan, is not secured against any assets. The amount you can borrow and the interest rates are determined based on your credit score.

Loan advantages

There are some key differences between overdrafts and loans.

Loan disadvantages

Although loans can be a good solution for long-term borrowing, there are some disadvantages to consider.

What alternatives are there?

An overdraft or loan might not be the best fit, depending on your personal requirements. Credit cards can be useful for those looking to spread the cost of a purchase. Consider a 0% purchase credit card for this sort of spending. Meanwhile, a 0% balance transfer credit card could help you consolidate existing debt.

Credit cards do have some downsides. Compared to a loan, credit cards often do not allow for borrowing of higher sums of money. Also consider that your deal for a 0% credit card could come to an end. This may result in high interest rates and adjustments to your monthly budget.

Look no further than our Know How section for more financial advice and information on loans.


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