When things get tight financially, or when larger purchases are planned, many consumers often have the question of the right financing. Most use the overdraft facility of their checking account in the event of financial bottlenecks. You can find out in this guide whether this is always the right solution or whether an installment loan would not be better.
The difference between an overdraft facility and an installment loan?
In order to make larger purchases, even if your own budget is not sufficient, consumers have two options:
- The use of the overdraft facility from your checking account
- The conclusion of a consumer loan (e.g. installment loan)
In the following sections, you will find out what is behind these two terms and what differentiates them.
Everyone has heard of it before, many have used it and some have already used it: The overdraft facility, often simply called “overdraft facility”. In principle, this is an overdraft of your checking account granted by the bank. In short: on certain terms, the bank allows you to spend more money than you actually have. In most cases, the amount of the overdraft facility granted depends on your regular earnings in the account.
In particular, if unforeseen expenses arise, the overdraft facility is gladly used. The main advantages here are uncomplicated and quick availability. So you don’t have to fill out any formalities and long application processes are also not necessary. The overdraft facility is requested once and can then be used according to the approved amount. The loan form is a typical example of the so-called credit line.
This comparatively high flexibility, however, is offset by the high costs of the overdraft facility. On average, consumers still pay around 8.5% in interest for using the overdraft facility (on the subject of over-indebtedness on Good Finance).
Overdraft interest may also apply if you debit the account beyond the agreed limit of the overdraft facility. There are banks that only charge very low-interest rates on the overdraft facility; however, this is the exception. Before using it, you should, therefore, find out about the conditions at your bank.
The installment loan for financing
An overdraft facility is only suitable for bridging short-term financial bottlenecks. For larger purchases, such as a new or used car, a kitchen or a trip, it is better to think about an installment loan. This is usually a better and cheaper option. On the one hand, an installment loan usually offers cheaper interest. On the other hand, there is a fixed installment payment or repayment plan. This way, both the bank and the borrower know when to pay which installment and when the loan is paid off. The risk of permanent debt is therefore significantly lower.
As already mentioned, installment loans are generally significantly cheaper than over drafting, which is why they are also very suitable for a possible debt rescheduling of an overdraft facility. The account quickly comes out of the minus and you can pay off the debts to the bank and fixed monthly installments at a significantly lower interest rate.
Overdraft facility or installment loan – what should you choose?
A credit facility can make sense to bridge short-term financial bottlenecks. Installment loans are a better alternative for long-term purchases. Anyone who has been in overdrafts for a long time should consider rescheduling using a loan. If the overdraft facility can be settled within a short time, you do not need a debt rescheduling loan. However, if you are in the monthly budget again and again and pay the expensive interest every month, then debt restructuring would be worth considering.
Examples of when an installment or overdraft facility is better
- Washing machine
A functioning washing machine is probably the backbone of every household. Such larger purchases should best be financed through an installment loan. So you have financial planning security. In addition, if there are further financial difficulties, you have a material equivalent that can be sold to repay the loan if necessary.
A car has become an integral part of everyday life in many areas. It enables more mobility and gives you flexibility. However, vehicles also cost several thousand euros. Here you should definitely resort to a car loan. Firstly, because the overdraft facility often does not provide the required amount. On the other hand, because the interest on a motor vehicle loan is significantly cheaper. You can also use the money from the loan to go directly to a car dealer of your choice and purchase a vehicle thereby cash purchase. This enables many retailers to have significantly greater scope when it comes to possible discounts.
- In addition to cost additional payment
Everyone has experienced it once in their life: The annual service charge is significantly higher. Now you have to get money quickly to pay for the bill. The payment term of the invoice should not be exceeded, as additional costs could arise from dunning costs. The overdraft facility granted can also be used for this. However, you should try to balance the overdraft facility as quickly as possible so that you do not have to pay the comparatively high-interest rates in the long term.
Conclusion on the overdraft facility or credit
A credit facility, i.e. the overdraft granted to the bank, gives a lot of financial freedom and flexibility. However, very high-interest rates have to be paid for this. It is well suited for bridging financial bottlenecks at short notice since it can be used without further formalities.
For larger purchases, however, you should use an installment loan. Thanks to the lower interest rates, this is not only cheaper. By setting monthly installments, you also have a stable size for long-term financial planning.