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  • Personal Loan vs. Overdraft

    A personal loan is usually your all-weather friend. You can get it for any purpose and repay it at a fixed rate of interest and over a predetermined period. However, many banks and alternate lenders in Singapore offer the option of borrowing through a secured overdraft facility. The primary difference lies in the nature of the loans, although fundamentally they serve the same purpose – solving problems related to shortage of liquidity.

    Let us now examine some of the similarities and differences between the two types of loans.

    Is It Secured or Unsecured?

    Personal loan: These loans are generally unsecured loans. If you fail to settle the dues, the lender can’t sell off your assets to make up for the loss. While most lenders won’t ask you to pledge an asset for a term loan, taking it for certain purposes may need you put up a security.

    Overdraft: This facility could be secured or unsecured. For secured overdraft facilities, a lender will usually use the value of your security to determine the credit limit that will be extended to you. While this could be of help when you don’t have a great credit score or history, you always risk losing your asset in case you fail to pay back your dues.

    For unsecured overdrafts, the credit limit is usually 4 times your monthly income as long as your annual income S$30,000 or more. The bank may also decide on the limit depending on your current financial standing and your credit history.

    What Is the Credit Type?

    Personal loan: This type of loan is usually a fixed, term loan. This means that the total amount – the sum of the principal and the interest – would be broken down into small instalments and you would have to pay that fixed amount over the entire tenure. While this may help when you’re trying to draw up a budget, it could also play to your disadvantage if for some reason you don’t use the money borrowed. This is because you’ll have to pay interest irrespective of whether you use the money or not.

    Overdraft: An overdraft is a revolving credit line. You’ll have to pay interest only for the portion of credit that you have used. Once you pay back the dues, the portion gets restored and you can redraw from the same credit line as long as the outstanding balance stays within your approved credit limit.

    How Is the Interest Calculated?

    Personal loan: The rate of interest usually remains fixed for these loans. This means that your payments won’t vary throughout the entire tenure of the loan.

    Overdraft: For overdrafts, interest is charged on the daily balance overdrawn. It gets added to the outstanding balance in your account. For unsecured overdrafts, the interest rate charged usually depends on the prime lending rate of the bank. For secured overdrafts, the interest is usually dependent on the value of the pledged asset. So, the interest could vary if the prime lending rate of the bank or the value of the asset, as assessed by the lender, changes.

    Tenure Options Available

    Personal loan: Tenures for these loans generally vary between 1 year and 5 years. It can, however, go up to 7 years – the HSBC Personal Loan , for instance.

    Overdraft: Overdrafts are usually short-term loans ranging from a few months to a year and usually need to be renewed at the end of the term. However, the bank can decide to terminate it even before.

    The Role of Credit Score in Loan Approval

    Personal loan: As these loans are usually unsecured, a lender puts a lot of stress on the assessment of your risk rating and credit profile. Securing a loan with a low credit score can become difficult.

    Overdraft: For secured overdraft facilities, your credit score won’t be a big factor because the value of the security pledged would be used as the most important determinant for approval. Credit assessment would play an important factor in approval of unsecured overdrafts but probably to a lower extent because the bank will be the sole determinant of your credit limit.

    The Minimum Repayment Required

    Personal loan: Term loans have a fixed instalment payment. Although there is no minimum payment per se, you have to pay the fixed payment due at the end of every month in order to avoid higher interest rates and penalties.

    Overdraft: There is no need for minimum payment as long as you borrow within your approved limit. Any outstanding balance will be rolled over to the next month. However, if you have drawn over the limit, the lender may ask you to pay the dues immediately, failing which, the account may be terminated. The bank may also impose penalty rates on the excess amount.

    Both term loans and overdrafts have advantages. However, the suitability of either would depend on the purpose of borrowing.

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