Choosing between a bank overdraft and a loan

August 17,2021

Choosing between a bank overdraft and a loan


If you're looking to borrow money, you need to know your options so you can make the right choice. For most people, that means taking out a loan or an overdraft. With this in mind, we've rounded up the pros and cons of both to make life a little easier.

What is an overdraft?

If you want to borrow money through your bank account, then an overdraft is an easy way to do it. You'll be able to borrow up to a set limit with no repayment date, and you'll usually pay interest on the money you borrow.

An arranged or authorised overdraft means you agree on how much you can borrow with your bank. An unauthorised or unarranged overdraft means you go into debt, or over your agreed overdraft, without the bank's authorisation. At one time, this could result in steep charges, but since April 2020, banks can only charge the same fees for an unauthorised and an arranged overdraft.

Who is an overdraft suitable for?

Overdrafts are generally smaller than loans and are sometimes interest-free but usually only for a set period of time or on lower amounts. For example, suppose you don't borrow very often and need a cushion in case of unexpected bills. In that case, an overdraft could be suitable for you.

What is a loan?

A loan is money you borrow and agree to repay over a fixed period of time, usually one to five years, in monthly instalments.

Most loans are unsecured, but if you want to borrow a large amount or you're considered a credit risk, you may need to use assets like your home to secure your loan. You should think carefully about just how you can repay if you take out a secured loan.

When it comes to repayment, you'll pay back the amount of the loan plus interest. Choosing a fixed interest loan means you'll be able to budget for your monthly repayments. A variable rate loan depends on the market, which means that your repayments could go up as well as down.

Who is a loan suitable for?

A loan could be the right choice for you if you want to make major home improvements, deal with unexpected expenses or consolidate existing debt. However, suppose you need to borrow more significant amounts. That would be a situation where you may need to secure the loan on your property which could be risky. 

Before you think about getting a secured or unsecured loan, be honest with yourself about your financial health. Then, before you do anything, check your credit score and make sure you'll be able to repay the loan without a problem. 

What are the pros and cons of an overdraft?

Pros

The advantage of an overdraft is the freedom it gives you to budget your finances. In addition, repayments are flexible, and you can pay off your overdraft at any time without penalty. What's more, you can increase, decrease and even cancel your overdraft at any time.

An overdraft also tends to be a cheaper option when it comes to short-term borrowing. You can dip in and out as you like - especially when payday is still a few days away.

Cons

The most significant disadvantage of an overdraft for borrowing is the lower lending limit. However, fees and charges on an overdraft can also be much higher than on a loan, making an overdraft an expensive option.

Because there's no fixed repayment term, it's easy to get used to living with overdraft debt. However, you should be aware that the bank can limit or even cancel your overdraft at any time. If that should happen, you could end up having to pay off a lump sum plus charges. And that could put you into financial difficulties.

What are the pros and cons of a loan?

Pros

Suppose your loan is approved, then the money could be in your account in as little as 24 hours, so you can start planning that wedding or new bathroom. And with a fixed-term loan, you'll have the advantage of being able to budget for your repayments every month.

Another advantage of a loan is the fact that you get to choose the repayment term, making it a good choice for long-term borrowing. You can usually borrow more, and you may find that the more you want to borrow, the lower and more competitive the interest rate. 

Cons 

The disadvantages of a loan are primarily to do with repayment. For example, if you miss a payment, you could negatively impact your credit score (unless your loan is with Salad Money who use Open Banking not credit score). You may also find that smaller loans have higher interest rates than larger ones which could tempt you into borrowing beyond your ability to repay.

Another downside is that you may be charged for early repayment even if you're in a position to clear the debt. On the other hand, if you don't keep up with the repayments on a secured loan, your property could be at risk.

Overdraft or loan - the bottom line

It's evident that there are benefits and downsides to overdrafts and loans. 

If you need some credit that you can dip in and out of, an overdraft could be the right choice. The application is simple, and you can usually do it via your banking app. Look for interest-free deals and check the small print, as you may need to make a minimum monthly payment to benefit from those headline deals.

A loan could be right for you depending on your project and whether you can put a credible repayment plan in place. However, failure to repay your loan will damage your credit history, which could make it unlikely you'll get credit in the future.

A different kind of loan

At Salad Money, we do things differently. We offer fair and affordable loans to NHS and public sector workers to help them get their finances back on track. You can have the money in your account in 24 hours to deal with those unexpected expenses or help pay for a well-earned break. And because you build your own loan and we use Open Banking to assess your ability to pay your loan back, it couldn't be simpler.

Why not contact us today or apply online and see how a Salad Money loan could help you.