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Term Loan Vs Overdraft Loan: Which One is Better?

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Posted on
Feb 03, 2023
Term Loan Vs Overdraft Loan

Whether big or small, every business needs funds to expand and carry out its day-to-day activities smoothly. This is where the role of loans for business comes into play. Companies or individuals can choose financing solutions based on their financing needs and requirements, like overdraft or term loans. But now the question is which is better: a term loan vs an overdraft? 

Read this article to understand the difference between a term loan and an overdraft.

What is a Term Loan?

A term loan is a fixed amount of money lent to the borrower for a specific period on a secured or unsecured basis. These loans come with fixed and variable interest rates, and as a borrower, you are free to choose either of the options. However, one must repay the loan in regular instalments, or EMIs, along with the interest amount spread over a predetermined term. 

Eligibility criteria for FlexiLoans Term Loan 

  1. Ongoing business for more than a year with monthly total sales of at least $2 million.
  2. One must be between 21 years and 65 years of age.
  3. Individual applicants must have 3 years of industry experience and overall 5 years of experience.
  4. The business should be tax compliant.

Advantages of a term loan 

  1. Interest on a term loan is tax-deductible.
  2. Ability to select tenure based on your income.
  3. Less expensive source of money for the medium-term. 
  4. EMIs reduce the burden on the borrower.
  5. Negotiable terms & conditions.

What is an Overdraft Loan?

An overdraft loan or overdraft is a facility offered by banks/financial institutions that allow customers to withdraw over and above their account balance up to a certain limit. This loan is best to fulfil financial emergencies. Businesses need to pay interest only on the amount borrowed and an overdraft fee paid at the beginning of the year. The best part about the loan is that lenders can repay the loan (maximum within 12 months) and continue borrowing as and when required.  

Eligibility criteria for FlexiLoans Overdraft Loan 

  1. Individuals between 18 years and 65 years of age.
  2. Your current account value defines the credit limit.
  3. A minimum monthly income.
  4. A healthy CIBIL score.

Advantages of an overdraft loan

  1. Less paperwork and document verification as compared to other loans.
  2. Aids in financial emergencies.
  3. It offers flexibility as one can avail loan at any time for any amount up to a specific limit.
  4. No security or collateral.

Difference Between Overdraft Loan and Term Loan 

Read the table below to understand the differences between the two. 

Basis Term Loan Overdraft Loan
Meaning  It is a fixed amount of money borrowed for a specific period. It is a facility that allows customers to withdraw money over and above their current bank account balance up to a specified limit.
Process Businesses need only submit the required documents to avail of the loan. Pre-entitled customers can directly withdraw extra money from their account, while others can request an overdraft from their lender and complete the required process.
Duration These are long-term loans. These are short-term loans (need to repay within 12 months).
Usage For numerous purposes, such as expansion, asset acquisition, salary payment, raw material purchase, and more. For working capital requirements such as paying wages, bills, etc., and to cater to emergency funds requirements.
Interest Fixed or variable interest is on the entire borrowed amount. The interest rate is on the borrowed amount used and not on the entire amount.
Repayment  Repayment through monthly instalments. Repayment by depositing amounts in the bank.
Limit The borrower can avail of only the sanctioned amount. Withdrawal of any amount of money up to a predetermined limit. 
Collateral  They can be both secured and unsecured.  Security/collateral not required. 

How to choose: overdraft vs term loan?

Factors based on which you can choose between the term loan and overdraft loan. 

  1. Amount required 

Opting for a term loan is your best bet if you need considerable money. On the other hand, overdraft facilities work like credit cards; thus, the limit is comparatively less. So, if you want a small loan, go for an overdraft loan.

  1. Purpose

Generally, businesses use overdraft facilities to fulfil working capital requirements and to cater to emergency financial needs. Apply for a term loan when you want to use the loan amount to expand your business by purchasing machinery, relocating the business, starting a new product line, and more.  

  1. Interest rate

The interest rate on overdraft loans is higher than on term loans. At the same time, you can choose between fixed and variable interest rates if you opt for a term loan.  

  1. Repayment 

The repayment of overdraft loans is more flexible than term loans. This is because failure to pay any of the EMIs can negatively impact your credit score.  

Conclusion 

Term loans are ideal when you want a vast amount of money for large investments, while an overdraft facility will help you fulfil immediate financial and short-term funds requirements. Identify the objective for which you wish to take a loan while considering various factors like interest rate, amount requirement, and repayment capabilities to make an informed choice. Once you decide, apply for a loan with FlexiLoans to get a quick disbursal. Moreover, you can apply for business, home, and many other types of loans with FlexiLoans. 

Frequently Asked Questions (FAQs)

Q.1 What is the tenor of a term loan?

Generally, a term loan tenure lies between 5 and 10 years.

Q.2 How is a secured loan different from an unsecured loan?

Secured term loans are those where you have to offer security or collateral to avail of a loan. In comparison, an unsecured loan is one where no guarantee is required. 

Q. 3 How much money can I withdraw from the overdraft facility?

You can withdraw money as and when required up to a sanctioned limit.

Q. 4 How is an overdraft loan helpful for business?

Overdraft loans can help businesses to

  • Maintain day-to-day activities.
  • Ensure smooth cash flow.
  • Meet immediate business expenses.  

Q. 5 What are the documents required to apply for a term loan?

Documentation differs for each lender. However, some essential documents to apply for a term loan with FlexiLoans, follow.

  1. Personal KYC.
  2. Residential address proof.
  3. Last 6 months’ current account bank statement.
  4. GST business certificate (for businesses).
  5. Audited financial statements.
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