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Overdrafts vs short-term loans
Are you considering an overdraft or a short-term loan? Learn where the differences lie and which option is best for you.
Overdraft accounts and short-term loans are both flexible options to consider. Although both may be solutions to similar financial problems, they work in different ways. It’s important to understand precisely where the differences lie and how each option can affect your short-term cash flow.
What are overdrafts and short-term loans?
An overdraft acts as a revolving line of credit, which links to a standard transaction account. It gives you access to extra money when you use up your own funds. Your bank will set the overdraft limit.
In contrast, a short-term loan is a lump-sum that a lender provides upfront and can range anywhere from $100 to $10,000. The short-term loan provider structures the repayment terms, which can be anywhere from two days to one year.
|Associated costs||Variable interest rates charged on the amount withdrawn.|
Monthly fees, annual fees and a one-off establishment fee may be charged depending on the bank.
|Make sure you read through the lender’s terms and conditions carefully, as they should be transparent about all costs.|
If you can’t see the interest rate on the lender’s website, check their product disclosure statement (PDS) or give them a call.
|Loan term||Ongoing||Usually two days to one year|
|Access and availability|
How do I decide between the two?
If you have a regular bank account and frequently find yourself in the red, an overdraft can protect you against overdrawn account fees. As it acts as a revolving line of credit, an overdraft is always available providing you make 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. Also, you can instantly access your funds.
In some situations, an overdraft may not be as useful. For example, if you need more funds than an overdraft can provide, a short-term loan may be a better option. Also, some people may not qualify for an overdraft. With a short-term loan, you can quickly access a lump-sum that a lender will provide within 24 hours.
Repayment terms for short-term loans can be anywhere from two days to a year, which allows for a quick repayment, which is useful for covering income gaps, to purchase essentials or cover expenses until payday (where other options aren’t possible).
How much will it cost?
- Variable interest rates. As you don’t secure an overdraft with collateral, lenders may charge a variable interest rate on your outstanding balance.
- Establishment fees. Upon the establishment of your account, providers usually charge a one-time establishment fee.
- Monthly or annual fees. In addition to the establishment fee, you may also pay monthly or annual costs. So make sure you’re fully aware of what the lender charges.
- Interest rates. These will vary according to the lender but can be as much as 1.5% per day.
- Other charges. Short-term loans also come with late, default and collection fees. Check with the lender before you sign a loan contract so you have a good understanding of what you will pay.
When considering an overdraft or a short-term loan, make sure you’re fully aware of the costs associated with each option. More importantly, make sure you understand how any finance option will affect your short-term cash flow and ability to make repayments.
⚠️ Warning: be cautious with short-term loans
If you're experiencing financial hardship and would like to speak to someone for free financial counselling, you can call the MoneyTalks helpline operated by FinCap on 0800 345 123. It is open from 8:00am to 5pm, Monday to Friday and 10am to 2pm Saturday. When comparing short term loans, ensure you take into consideration any fees, charges and rates you may be charged.
Alternatives to short-term loans
Consider these alternatives before applying for a payday loan:
- Use online Government resources. The Commerce Commission New Zealand website explains how loans works and what to be aware of when borrowing from a lender.
- Payment plans. Talk to your electricity, gas, phone or water provider to see if you can work out a payment plan or receive an extension on your due date if you’re behind on payments.
- Contact your creditors. Speak with creditors about extending the due date of your payment, or working out a new payment plan that works for both of you. Seek personal loans elsewhere. Consider a small personal loan from a bank or a credit union. You may qualify for a loan with much lower interest rates than those offered by payday loan companies.
- Pay with credit card. Consider paying with your credit card to cover your emergency bills or payments. This is not a long term solution, as you’ll need to pay off the balance as soon as possible, but it’s an alternative to a short term loan with high – and immediate – interest rates.
Compare a range of short-term loans
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