Overdraft or a personal loan

If you’re thinking about making a big purchase or want to have some peace of mind you can cover any unexpected expenses that come up, you may be looking into an overdraft or a personal loan.

The next question you might ask is: what are the differences between a personal loan and an overdraft? The simplest explanation is that an overdraft can be used indefinitely, while a personal loan has a set repayment term.

Overdraft

An overdraft is a line of credit you can attach to your transaction account to cover bigger purchases and unexpected expenses. It’s a temporary increase to your account balance that does attract interest when you draw on it. The amount of interest can be less than a credit card, but will usually be more than a personal loan.

How does an overdraft work?

You can set up an overdraft to cover those times when you need more funds than your account has available. When your account balance reaches zero, the overdraft will kick in. This could be to replace an old or broken appliance or to cover another unexpected emergency.

If you have an approved overdraft limit of $1,000 available on your account and you use $500 of it in one month to pay for emergency car repairs, you’ll only be charged interest on the $500. If you don’t use any of the overdraft amount you won’t be charged any interest, but be wary of providers who charge ongoing maintenance or account keeping fees to keep the overdraft active on your account.

You don’t have to use an overdraft just in an emergency either. You can use the overdraft for any reason, such as easy access to extra funds for your next holiday or to help fund a renovation project.

What to watch out for with an overdraft

Like with a credit card, just because you have the extra money available doesn’t mean you should spend it. You’ll have to pay the balance back along with any interest or fees attached.

• Look for an overdraft with no or minimal establishment and ongoing fees to minimise costs.
• Make sure you can repay the balance in full as quickly as possible.
• If you find yourself constantly using your overdraft, take the time to review your spending habits to see where you can improve.

You should think of it like any other financial product and keep a close eye on your account so you know when you might need to access your overdraft.

Personal loan

Another difference between an overdraft and a personal loan is an overdraft is an ongoing credit increase you can draw on when you need it with no fixed repayment terms. A personal loan, on the other hand, will have a fixed term and agreed repayment amounts you must meet as a condition of the loan. Personal loans are also usually taken out for a specific purpose, such as to buy a car, go on a holiday or consolidate other debts, whereas an overdraft can be used for a variety of different purchases during the time period you have it.

How does a personal loan work?

When you submit your loan application to a lender, the lender will look at a number of factors to determine if your application will be successful. This generally includes payslips, spending habits, your savings and your credit history. The lender may also ask what you are using the loan for and if there is anything they can secure it against, to both lower their risk and give you a lower interest rate. Once approved, a lump sum will be deposited into your account and you’ll be able to make your purchase.

Repayments start on the full balance as soon as the money is made available to you. If the cost of what you’re purchasing decreases and you don’t use the full value of the loan – for example, if you negotiate a lower price with the seller of the car you are buying or if your home renovations come in under budget – you will still need to repay the full amount. While you may be able to make large, one off repayments or regular additional repayments, the lender may charge a fee for this.

What to watch out for with a personal loan

Do your research before taking out a personal loan. Take the time to determine what you need, how much you can afford and what features are important to you, such as making extra repayments, no ongoing fees and a flexible repayment schedule.

• Find the right loan for your needs, whether that’s secured or unsecured, a general all-purpose loan or a specific car or travel loan.
• Be wary of fees that can cost you more over the life of the loan, such as account keeping or early payout fees.
• Check the comparison rate to get a better understanding of the total cost of the loan.

Which should you choose?

As with all financial decisions, the choice you make will come down to your individual needs and circumstances.

The table below can help you decide which option might work for your situation:

The bottom line

Both overdrafts and personal loans give you access to additional money when you need it. Before making any decisions, work out whether you need to borrow the money, or if you can save up for what you need instead.

Always make sure you can afford the repayments and know where to turn if you start to have difficulty making your repayments. The UniBank Credit Assistance service can help you work through rough financial patches and will work with you manage your financial obligations with us.

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