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Types
Overdrafts vs short term loans
A guide to the differences between a short term loan and an overdraft, and how to compare them
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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 for customers looking for access to a a bit of extra money understand exactly where their differences lie, and how each option can affect someone's short-term cash flow.
Are you struggling financially?
If you're struggling financially and would like to speak to someone for free financial advice, information and assistance you can call the Financial Counsellors hotline on 1800 007 007 (open from 9:30am to 4pm, Monday to Friday). If you are suffering financial problems related to the coronavirus pandemic you may be eligible for additional support. Find out more here: https://www.finder.com.au/coronavirus-financial-help
⚠️ Warning about Borrowing
Do you really need a loan today?*
It can be expensive to borrow small amounts of money and borrowing may not solve your money problems.
Check your options before you borrow:
- For information about other options for managing bills and debts, ring 1800 007 007 from anywhere in Australia to talk to a free and independent financial counsellor
- Talk to your electricity, gas, phone or water provider to see if you can work out a payment plan
- If you are on government benefits, ask if you can receive an advance from Centrelink: Phone: 13 17 94
The Government's MoneySmart website shows you how small amount loans work and suggests other options that may help you.
* This statement is an Australian Government requirement under the National Consumer Credit Protection Act 2009.
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 the user access to extra money when they've used up the funds in their account. The customer's financial institution sets their overdraft limit, usually based on the customer's circumstances.
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 |
|
|
| Loan term | Ongoing | 16 days to two years |
| Access and availability |
|
|
How do I decide between the two?
Overdraft accounts
If someone has a normal bank account and frequently find themselves in the red, an overdraft can protect them against overdrawn account fees. Since an overdraft acts like a revolving line of credit, it’ll always be available as long as they're making repayments towards their balance.
An overdraft account can be a practical solution for repeat borrowing scenarios, especially since users don’t have to keep reapplying for a new loan. Also, they're always able to instantly get access to their funds, either via online banking or simply by using their debit card.
Short-term loans
In some situations, an overdraft may not be so useful. For one, if someone needs more funds than what an overdraft can give them, a short-term loan may be another option. Also, some people may not qualify for an overdraft. With short-term loans, customers are able to get 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). However, short-term loans are not long-term financial solutions, and usually come with the maximum fees and interest attached to them. Even small loans can end up being very expensive very quickly.
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 an overdraft, customer's will usually be charged a one-time establishment fee.
- Monthly or annual fees. In additional to the establishment fee, someone may also be charged monthly or annual fees. So they should ensure that they're fully aware of what fees their lender charges.
Short-term loans
- Interest rates. Customers will not be charged an interest rate unless they 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. Customers should check with a lender before they sign a loan contract, so they have a good understanding of what they might pay.
In either case, when considering an overdraft account or short-term loan, prospective applicants should make sure they're fully aware of the costs associated with each option. More importantly, they need to be completely aware of how any financing option will affect their short-term cash flow and their ability to make repayments.
Compare a range of short-term loans
Picture: Shutterstock
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