Overdraft Facility vs. Term Loan — What’s the Real Difference

Both can fund the same need - a home renovation, a business expense, a large purchase - but they work fundamentally differently, and the difference matters more than most borrowers realize before comparing them side by side.

How a term loan works

You’re sanctioned a fixed amount, disbursed in full (or in scheduled tranches for something like a construction-linked home loan), and you repay it through a fixed EMI schedule over a fixed tenure. Interest is calculated on the outstanding principal per that schedule, regardless of whether you actually needed all the money on day one or whether you could have repaid faster in some months and slower in others. The structure is predictable, which is exactly its appeal - you know your exact monthly obligation for the life of the loan.

How an overdraft facility works

You’re sanctioned a credit limit, not a lump sum. You draw down what you need, when you need it, and interest is charged only on the amount actually outstanding at any given time - not on the full sanctioned limit. You can repay early and redraw later without re-applying. There’s typically no fixed EMI schedule in the same sense; you have flexibility in how and when you bring the outstanding balance down, within the facility’s terms.

The headline-rate trap

This is the part that catches people off guard: overdraft facilities often carry a higher headline interest rate than an equivalent term loan for the same borrower profile. On paper, that makes the term loan look cheaper. But because OD interest is charged only on what’s actually drawn - not the full limit - the real-world cost can end up lower than the term loan if you don’t need the full amount continuously. A business owner who draws ₹10 lakh against a ₹20 lakh OD limit for three months, then repays it, pays interest on ₹10 lakh for three months - not on ₹20 lakh for the full tenure a term loan would have assumed.

When each one actually fits

A term loan tends to fit better when you have a single, known expense with a clear amount and timeline - buying a specific asset, funding a fixed-cost renovation - where predictable EMI budgeting matters more than flexibility.

An overdraft tends to fit better when your cash flow is irregular or seasonal - common for business owners and self-employed professionals - where the amount you actually need fluctuates month to month and paying interest on an unused balance would be wasteful.

This exact comparison - what an overdraft facility would actually cost you given your real draw-down pattern, versus a standard term loan - is what the Loan Strategy Analyzer runs with your actual numbers rather than a generic example.