Personal Loan vs Overdraft – Which Is Right for You?

From time to time, you might need access to a bit of extra money.

Maybe you’ve had an unexpected expense pop up, you need to make a large purchase, or you have a gap in your cash flow. Consider simple tweaks to free up $50–$100 a week to help cover these costs.

Sometimes, an overdraft or personal loan can help in those situations.

Here’s what you need to know about each, and how to decide which might be right for you.

What is a Personal Loan?

A personal loan is a loan you take out in your own name. You borrow a sum of money from a lender, and pay it back, plus interest, over a period of time.

The repayments stay the same for the term of the loan.

Personal loans may be used for almost anything, including paying for the purchase of a car, minor home renovations, or debt consolidation.

Pros

• Personal loans have a set end date. If you make your repayments on time, you’ll repay the debt by the end of the loan term.

• You can sometimes access lower interest rates with personal loans than you might pay with other forms of personal lending, particularly if the lender is able to take security for your loan.

Cons

• There can sometimes be fees associated with paying back the loan more quickly.

• If you need access to more money while you’re paying back the loan, you will probably need to apply for a new loan or extend your existing one.

What is an Overdraft?

An overdraft is a set amount that you’ve been approved by your bank to spend over the amount that you actually have available in your account. You might have a transactional account, for example, with a balance of $1000 but an approved overdraft limit of $6000, meaning you can spend up to $7000.

People generally use overdrafts for short-term cash flow situations, where they need access to money for a short period of time.

Pros

• Once the overdraft is approved and you’ve signed the overdraft agreement, access to the money is generally provided quickly.

• You can pay it back as quickly or slowly as you like – there may be no set repayments.

Cons

• The interest rate may be higher than for a personal loan.

• If there are no set repayments (limit reductions), there’s no surety that you’ll pay the overdraft back unless you’re committed and disciplined to do so.

Key Differences Between Personal Loans and Overdrafts

There are a few important differences between personal loans and overdrafts, which may play a role if you’re deciding which might be appropriate for you.

Structure and access

A personal loan is more structured, with an initial sum of money given to you at the start of the loan, and repayments made on a schedule. An overdraft gives you an amount you can access, but often no set requirements around when or how you repay it.

Interest rates and fees

Personal loans will often incur a fee when they are set up, and there is interest charged over the course of the loan, usually at a fixed rate. At better finance™, a typical personal loan interest rate can be anything from 9.95 percent to 29.95 percent per annum. In contrast, overdraft rates can change but are typically about 20 percent at New Zealand’s main banks. You might also be charged service fees.

Repayment terms

A personal loan will come with a schedule of repayments, whereas an overdraft may have more flexibility with repayments.

Credit impact and approval process

You can usually apply for an overdraft with your bank through its online banking platform. Similarly, you can apply for a personal loan through better finance™’s straightforward online system. In both cases, while the initial application may impact your credit record, paying back the debt over time and showing you can manage the credit could improve your score.

Comparing Costs: Personal Loan vs Overdraft in New Zealand

If you’re borrowing $5000:

A personal loan from better finance™

A loan of $5000 over six months at an interest rate of 10.95 per cent might cost you $950 a month; you’ll pay a total of $5700, including fees.

Overdraft

If you don’t make any repayments on your overdraft or keep drawing it back down again, your total interest costs could accumulate significantly. But if you pay it back at a rate of about $100 a week, you could clear it just over a year, according to Sorted’s calculator, providing you’re not drawing any more down on it in the meantime.

Additional costs

Whichever option you choose, it’s important to make sure you understand any set-up or ongoing fees that might be charged, and any penalties that could apply. For a personal loan, that might be for early repayment. For an overdraft, it could be if you go over your limit.

Signs a Personal Loan Might Be Right for You

• You like the structure of a repayment schedule

• You want to know you’re going to clear your debt by a certain date

• You’re unlikely to have lots of extra cash to put towards your debt

Signs an Overdraft Might Be Right for You

• You only need to borrow money for a short term to tide you over until you have the expected money coming into your account

• You’re likely to be able to pay the amount back relatively quickly

Common Mistakes to Avoid

As with any borrowing decision, it’s important to take your time and approach it with care.

It’s usually a good idea not to borrow more than you need to, because it means paying more interest than you have to.

It’s also a good idea to think about how your circumstances might change while you have the debt, and to make sure you understand the fine print of the loan.

Making a decision?

You’ll probably want to weigh up things like how a personal loan or overdraft will fit into your overall financial situation, the total costs you’ll incur and what your options might be.

We can help. At better finance™, we’re personal loan experts who can answer any questions you may have about the possibilities available to you. We can give you personalised advice and help you through each step of the process if you decide a personal loan is right for you.

Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion and seek independent guidance.