Describe Term Loan
Since the sanctioned or requested amount is paid to the customer’s registered bank account, the term “Term” itself denotes that the loan is for a preset period that the consumer chooses before disbursement.
Numerous loan programs, including Personal Loan, Business Loan, etc., choose the same strategy. The EMI calculation does, however, differ depending on the type of loan.
Let’s use the example of a situation where the user needs to use the entire sanctioned amount at once and the principal amount and interest are repaid in regular EMIs over the stipulated period as an illustration and for simplicity. This is a basic instance of a term loan that is typically referred to as a personal loan.
What is Overdraft
On the other hand, an Overdraft facility provides a pre-approved credit line for a defined period, here the user has the flexibility to request for disbursement within the sanctioned limit and period as per need and repay whenever borrower has surplus or availability of funds, the interest will be calculated only on the amount utilised and not on the entire credit line.
Term Loan Vs Overdraft : Which is Better?
Now, which is a better term loan or overdraft? Let us simplify this by highlighting the key features of these products
| Overdraft – Drop line | Overdraft – Straight line | Term Loan | Features |
| Disbursement | One-time disbursement | Subsequent disbursements on request | Subsequent disbursements on request |
| Credit limit | 100% utilized at the time of disbursement | Available for the sanctioned period | Keeps on dropping with tenure |
| EMI | Consists of principal and interest of the disbursed amount | Consists of interest on the utilized amount | Consists of interest on the utilized amount |
| Part-prepayment Charges | May be chargeable, depending on the lender | Generally, there is no part-prepayment charges but depends on the lender | Generally, there is no part-prepayment charges but depends on the lender |
| Best Used For the MSME | If you are aware of the end use and do not want to manage the EMI calculation like OD | If your fund requirement is irregular short term but you want to have a cushion of a credit line. | If you need funds for a longer tenure with higher limit and at the same time wants to minimize the interest amount |
| Suitable for individuals to manage day-to-day lifestyle needs and looking for flexible options to repay | Best use case is for |
Types of Overdrafts
To explore more on Overdraft (OD), let us explain the variants of OD that are generally offered by the lenders
Straight-line Overdraft
This product is for someone who wants to maintain a day-to-day lifestyle with unpredictable needs and doesn’t want to have the burden of bigger EMIs. The best part of this product is that you have flexibility to repay whenever you have the funds available, and the interest is calculated only on the utilised amount and not on the entire sanctioned limit. The EMI will be the interest computed on the utilised amount. The interest will be applicable if the principal remains unpaid. The payment of the principal amount can be done at the borrower’s will if the interest is being paid.
Illustration: Imagine you got a sanctioned limit of Rs 2 lakh for 12 months; you withdrew 1 lakh on 6th month and before 8th month you repay 1 lakh. The EMI will be computed only on the interest amount applicable on Rs 1 lakh. The credit line of 2 lakh remains sanctioned for you for the remaining period. Before the end of the term of 1 year, you need to pay back the principal and interest.
Drop-line Overdraft
Unlike straight line OD, this product is generally opted for longer tenure and for high credit value, here the user has the same flexibility of utilising the amount from the pre-approved credit line, but the difference lies on the credit limit where the available credit line keeps on dropping after every tenure. During the tenure period, the interest gets calculated only on the withdrawn amount and the EMI consists of both principal and interest.
Illustration: Taking the same above example, for a sanctioned limit of Rs 2 lakh for 12 months, the available credit limit will keep on dropping after subsequent tenure proportionally and on 12th month the available limit will be 0. For a sanctioned limit of Rs 2 lakh for 12 months, you can withdraw 1 lakh on the 6th month as the line keeps on dropping. You can repay anytime you wish but the EMI will consist of principal and interest for the utilised period.
Types of Term Loan
Term loans are classified based on their loan tenure. There are mainly three types of term loans, short-term loans, medium-term loans, and long-term loans.
Short-term loans: These loans can be availed of for 1-2 years, as the name suggests. The funds can be used for covering day-to-day expenses, and for fulfilling working capital requirement. However, these loans come with a slightly higher rate of interest as compared to medium and long-term loans.
Medium-term loans: Medium-terms loans are given to borrowers for a tenure up to 2-5 years. The documents required for these loans are comparatively simpler than long-term loans. The interest rate is also comparatively higher.
Long-term loans: These loans are unsecured and are offered for a tenure more than 5 years. These loans come with flexible repayment options and the rate of interest in lower.
