Considering an overdraft or short-term loan? Learn where their differences lie and which option is best for you.
Overdraft accounts and short-term loans are both flexible options to consider. Although both overdrafts and short-term loans can be solutions to similar financial problems, they work in different ways. It’s important you understand exactly where their differences lie and how each option can affect your short-term cash flow.
What are overdrafts and short-term loans?
Overdrafts act as a revolving line of credit linked to a normal transaction account. An overdraft account gives you access to extra money when you’ve used up your own funds in your account. Your financial institution will set your overdraft limit.
In contrast, short-term loans are lump-sum loans disbursed upfront and can range anywhere from $100 to $10,000. A short-term loan has structured repayment terms that can be anywhere from a few weeks to one year.
| Overdraft | Short-term loan | |
|---|---|---|
| Associated costs |
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| Loan term | Ongoing | 16 days to two years |
| Access and availability |
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How do I decide between the two?
Overdraft accounts
If you have a normal bank account and frequently find yourself in the red, an overdraft can protect you against overdrawn account fees. Since an overdraft acts like a revolving line of credit, it’ll always be available as long as you’re making repayments towards your balance.
An overdraft account can be a practical solution for repeat borrowing scenarios, especially since you don’t have to keep reapplying for a new loan. Also, you’re always able to instantly get access to your funds.
Short-term loans
In some situations, an overdraft may not be so useful. For one, if you need more funds than what an overdraft can give you, a short-term loan may be a better option. Also, some people may not qualify for an overdraft. With short-term loans, you’re able to get quick access to lump-sum loans that are disbursed within 24 hours.
Repayment terms for short-term loans can be anywhere from a few weeks to a year, allowing for quick repayment. This is useful for covering income gaps, to purchase essentials or to cover expenses until payday (where other options aren’t possible).
How much will it cost?
Overdraft accounts
- Variable interest rates. Since overdrafts aren’t secured by collateral, lenders usually charge variable interest rates on your outstanding balance.
- Establishment fees. Upon the establishment of your account, you’ll usually be charged a one-time establishment fee.
- Monthly or annual fees. In additional to the establishment fee, you may also be charged monthly or annual fees. So make sure you’re fully aware of what fees your lender charges.
Short-term loans
- Interest rates. You will not be charged an interest rate unless you borrow $2,000 or more. Loans under this amount come with set fees. Loans between $2,001 and $5,000 come with a maximum annual rate of 48% p.a.
- Establishment and monthly fees. Loans under $2,000 come with an establishment fee of 20% and a monthly fee of 4%. Loans between $2,001 and $5,000 come with an establishment fee of $400 in addition to the 48% p.a. rate.
- Other fees and charges. Short-term loans also come with late fees, default fees and collection fees. Check with the lender before you sign a loan contract so you have a good understanding of what you might pay.
In either case, when considering an overdraft account or short-term loan, make sure you’re fully aware of the costs associated with each option. More importantly, be completely aware of how any financing option would affect your short-term cash flow and your ability to make repayments.
