Which is better – a loan or an overdraft? – Forbes Advisor UK

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If you are looking to borrow money, you might be wondering if a loan or overdraft is the best choice. We take a look at both options to help you make a decision that’s right for you.

What is a loan?

A loan typically allows you to borrow a fixed amount of money over a fixed period of time (called a “term”) – often between one and five years, although some providers extend this term to seven years or even more.

You then repay the borrowed amount in monthly installments plus interest. Interest rates can be fixed for the duration of the term, which means you know your repayments amount, or they can be variable depending on market conditions.

Who is a loan for?

Loans can be a good option if you are looking to finance home improvements, pay for a new car, or consolidate existing debt. You can usually borrow between £ 1,000 and £ 25,000.

Choosing an unsecured personal loan is less risky than a secured loan, which will require you to use an asset such as your home as collateral.

If you take out a secured loan and are having trouble meeting your repayments, your lender has the legal right to repossess your property and force you to sell your home.

However, secured loans often allow you to borrow larger amounts (over £ 25,000), and interest rates can also be lower as they are less risky for lenders because of the collateral they are on. can fall back.

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What is an overdraft?

Overdrafts allow you to borrow money through your bank account, up to a certain limit, with no defined repayment date. Some overdrafts may be interest free, but more often than not you will be charged interest on the amount borrowed. Interest rates are generally variable.

An authorized or arranged overdraft is a limit agreed upon in advance with your bank, and you can spend up to that limit.

An unauthorized or unauthorized overdraft occurs when you spend more than you have in your checking account and have not agreed to an agreed overdraft limit with your bank, or when you exceed the limit by one. Overdraft.

New rules introduced in April 2020 mean that banks can no longer charge higher fees for unauthorized overdrafts than for authorized overdrafts.

Who is an overdraft for?

Since overdraft limits are usually much lower than a loan (usually between £ 500 and £ 2,000), an overdraft is better suited for short-term borrowing – for example, if you have to pay loan fees. emergency or to help you. until your next breakdown.

What are the advantages and disadvantages of a loan?

Benefits

  • Funds can be approved quickly – often within 24 hours
  • Monthly payments are fixed, which makes budgeting easier
  • You can choose the repayment term, usually up to five years but sometimes longer, making it a good option for long term borrowing.
  • Interest rates can be competitive, especially on loan amounts of £ 7,500 or more
  • You can usually borrow more money than with an overdraft.

The inconvenients

  • Payments are not flexible, so if you regularly miss monthly repayments it could negatively affect your credit report.
  • If you are only looking to borrow a relatively small amount, say £ 2,000, the interest rates can be much higher than on amounts of £ 7,500 or more.
  • Some loans are secured against your home, putting the roof over your head at risk if you can’t keep up with repayments.
  • There can be expensive prepayment charges.

Advantages and disadvantages of an overdraft

Benefits

  • Payments are flexible
  • You have the possibility to increase, decrease or cancel your overdraft at any time
  • There is no repayment term – you can repay the borrowed amount as and when you want
  • You can move in and out of your overdraft as needed.

The inconvenients

  • Interest rates can be high, making it an expensive way to borrow
  • Borrowing limits are much lower than with a loan
  • Your bank can reduce the limit or cancel your overdraft at any time
  • Since there is no repayment term, it can be easy to keep your overdraft permanently.

Which one is right for me?

If you are looking to borrow a few hundred dollars, perhaps to cover boiler repairs for example, an overdraft can be a useful option.

The application process is quick and easy – you can usually do it from a banking app. Your bank will usually do affordability checks before telling you how much you can borrow. If approved, your overdraft will often be ready for use immediately or, failing that, within days.

To save money, it’s best to look for an interest-free overdraft – at least for a fixed term – which may involve changing your checking account. Nationwide’s FlexDirect checking account, for example, offers an interest-free overdraft of up to £ 1,500 for 12 months.

Be sure to check the fine print carefully, however, as you’ll often need to meet certain eligibility criteria and pay a set amount each month. Nationwide requires you to pay at least £ 1,000 per month.

If you can’t get an interest-free overdraft, be sure to pay off your overdraft as soon as possible to avoid high interest charges.

If, on the other hand, you need to borrow a much larger amount, perhaps to finance major or substantial renovations, a loan is likely to be a better option.

If you need to borrow more than £ 25,000 you may want to consider a secured loan, but remember that you will be putting your home at risk, so this is not a decision to be taken lightly.

Whatever loan you choose, make sure you have a repayment plan in place and that you can afford to make your monthly payments on time every month. Failure to meet your repayments can negatively affect your credit score and affect your chances of getting credit again in the future.

Are there any alternatives?

Another popular way to borrow is with a credit card. The type of credit card you choose will depend on what you need it for.

A 0% credit card purchase, for example, will allow you to spread the cost of an interest-free purchase over several months, while a 0% credit card balance transfer can be a good choice when it comes to consolidating existing card debt at a lower cost.

A 0% credit card money transfer, meanwhile, lets you transfer funds from your credit card to your checking account, and then use that money to pay off debt or finance a purchase.

Keep in mind that after the 0% offer ends, interest will kick in and most balance transfer and money transfer cards will charge a transfer fee.

Credit cards usually only allow you to borrow a few hundred or a few thousand pounds, so the limit may not be high enough to meet your needs.

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