What’s the difference between an Overdraft and a Term Loan
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If you’re looking to borrow funds for your business, you might be considering a range of funding options.
Two of the most popular that are considered by most companies are overdrafts and loans. We explain the differences – and round up the pros and cons of both.
A loan is simple to define. It is an arrangement that lets you borrow a cash lump sum. You repay it, with added interest, usually with monthly instalments. It is also known as Debt Finance.
There are two main types. An Unsecured or Personal Loan is based on your creditworthiness as an individual and on the creditworthiness of your business.
Secured Finance, on the other hand, will usually be secured against your property – which means that the lender will have the right to take your property if you do not keep up the loan. These can be less expensive – they have lower interest rates because the risk to the lender is lower. For the same reason, they can also provide much higher sums if required. Short-term loans are typically repaid over one to three years, while long-term loans can usually be paid off over a much longer timeframe - and terms or 10 years or more are not uncommon with secured lending. The arrangements can vary depending on the deal, provider and the amount of money you’ve borrowed.
Borrowing can range from tens or hundreds to hundreds of thousands of pounds with Secured Loans, but whatever the sum you want to borrow, it’s important to ensure that you’ll be able to afford to repay the amount and have a plan in place to make your repayments on time.
The advantages of a loan
- They can be arranged fast - some smaller unsecured loans can be arranged in a matter of hours
- The interest rates tend to be fixed so you’ll know what you’ll be paying each month
- A good credit history is valuable – but it still may be possible to arrange a loan if your history show problems with repayments in the past
- Loans can be tailored to particular needs
- You can choose secured or unsecured options in many cases
The disadvantages of a loan
- The interest on a personal loan can be high if you’re only borrowing a small sum
- Secured loans can allow you to borrow more, but they are linked to high-value assets such as your property - this means if you are unable to keep up with your repayments, there is a risk you could lose your home
- Loan repayments are usually less flexible – the criteria is set by the lender, so it’s worth talking to them if you think you won’t be able to make them in time
- If you want to repay your loan early, there may be an early repayment fee
A traditional agreed overdraft facility allows you to borrow money through your bank's current account up to a certain limit. It is very easy to use once it has been set up – your bank allows you to draw down funds that you don’t have in your current account as though you did.
You can repay these funds as soon as you have cash available.
You will usually have to pay interest or fees on the money you take out under your overdraft. There may still be a few banks that offer interest or fee-free overdrafts, but these will typically only apply up to a relatively low limit or for a set time.
Banks used to offer overdrafts automatically for business banking customers, but many banks no longer offer overdrafts at all or restrict their availability. As a result, Alternative Overdrafts have become more common. With these, no bank account is involved and, instead, there is a line of credit provided by a lender which you may dip into as you require, paying only for the money you draw down and the time in which you borrow it.
Overdrafts may give you access to funds of up to £2,000 or so, but how much you can actually draw down will vary depending on both your credit score and your income. Overdrafts have no specific repayment date, but it’s best to try and clear them as soon as possible – particularly if you’re being charged interest.
The advantages of an overdraft
- You have flexible borrowing and repayments, which gives you some freedom to decide how much money you use and repay each month
- An overdraft tends to be the cheaper option for short-term borrowing, especially if you are you able to access one that doesn’t charge interest
- It can provide a financial safetynet to help you deal with unexpected costs or take advantage of an opportunity - knowing that the cash you need is ready and waiting
- Very short-term borrowing - for days or even hours - is simple and cost-effective
Disadvantages of using an overdraft
- The amount of money you can access through your overdraft tends to be lower than with a personal loan
- Fees and interest charged on overdrafts can be high – especially if you go over your agreed limit – making it an expensive way to arrange funding
- An overdraft should not be considered as the solution for long-term funding, or for high levels of borrowing because of the costs involved.
Getting help with the funds you need
At Rangewell, we can provide solutions both for loans and overdraft replacement funding.
We can help you decide on the most appropriate type of funding for you and search the entire lending market to find the most competitive rates for you and your business.
That means, loan or overdraft, we can help you pay less for the funding you need.
To find out more about working with Rangewell to find better answers to your funding needs simply call us. Our service is free.