Compare Business Loan and Overdraft – Find the Better Choice

Overview

An entrepreneur who wants to start a new business or is thinking of expanding his or her existing business needs finance to fulfil his or her business objectives. At such a time, an individual would think of procuring a business loan or getting an overdraft to meet his working capital requirements. There is much to discuss on business loan vs overdraft. Both financial products provide funding support to their borrowers. At the same time, both products have distinct features and differences.

What is a business loan?

A business loan is also known as an unsecured loan. However, in some cases, business loans can be secured and require a collateral submission to the lender. This loan is useful for achieving various business purposes, such as expansion of business, meeting working capital needs, buying property or land, purchasing of plant or machinery, hiring of staff, training of employees, procurement of raw materials, enhancement of stocks and inventory, and so on. Read on for business loan vs overdraft.

What are the types of business loans?

The most common forms of business loans offered in India are as follows:

• Working Capital Loan: Business owners, individuals, MSMEs, and startups commonly use this type of loan. They can use it for different business developments, and it can also suit their daily business needs.
• Letter of Credit: This sort of credit limit is mostly used by trading companies. It provides funding assurances to businesses engaged in trade across borders. Letters of credit are a tool that business owners can utilize for import as well as export transactions.
• Term Loan: It is a type of loan that you should pay back over a predetermined period in regular instalments. There are three types of term loans: short, intermediate, and long. This category’s repayment terms span from one year to five years.
• Point-of-Sale (POS) Loans: It is a method through which a company owner operating a business gives a one-time payment in advance to vendors through their regular or upcoming credit or debit card transactions. This practice is also known as merchant cash advance.
• Bill Discounting: This is a finance option, also known as invoice discounting, when the lender gives the seller money up front at a reduced rate.
• Equipment Finance or Machinery Loan: This loan is available to the borrowers to upgrade or buy new machinery or equipment.

What is an overdraft?

An overdraft is a credit facility permitting an individual to withdraw money from the current account even in case of zero balance. This overdraft facility is useful for fulfilling short-term business objectives and requirements and during emergencies. The interest rate or the overdraft fee imposed over the withdrawal is determined by the financial institution availing this facility, and it varies according to the bank. Moreover, one can borrow money over and above his or her account credit balance.

What are the types of overdrafts?

A small business wishing to reduce interest costs will find overdraft as the best option. A salaried or self-employed individual requiring extra money can also benefit from an overdraft. Banks and NBFCs often offer business owners and individuals various overdraft options.

The following constitute some of the most common forms that you should be aware of:

• Overdraft Against Insurance Policy: It often depends on the insurance policy’s surrender value, which serves as collateral in the event of default.
• Overdraft Against Property: Homeowners who are also business owners may borrow up to 50% of the value of their property.
• Overdraft Against Fixed Deposit: If an individual keeps a fixed deposit account with the bank, they can withdraw funds up to a predetermined percentage of the deposit amount.
• Overdraft Against Savings Account: Customers who regularly conduct business and hold a savings account with a bank or NBFC are eligible for overdraft against savings accounts.
• Overdraft Against Equity: A borrower can get this facility by pledging certain equity shares as security.
• Overdraft Against Salary: It usually applies to salaried individuals who may have a salary account with the bank.

Comparison between a business loan and overdraft facility

Here is a rundown of business loan vs overdraft:

Pros and cons of procuring a business loan

Taking a business loan is not a decision to be taken on an impulse. Many aspects are to be considered before making this decision. An individual may choose to take business loans for various reasons as it may seem to be the most viable option in case there is an investment for a higher amount and a more extended period. Moreover, most of the banks and NBFCs offer loans with a fixed rate of interest, which enables an individual to have proper knowledge of repayable amount within a specific duration.

A few reasons as to why an individual may think of going for a business loan vs overdraft are:

1. Borrowing a higher amount of money for a longer duration of time
2. The interest rate may be fixed throughout the loan term of the loan

The cons of getting a business loan vs overdraft are:

1. Higher rate of interest in case of loan for personal use with a small amount 
2. Borrowing of secured loans with more significant amounts is available. However valuable assets may be pledged for the same. The risk in such investments is such that in case of non-repayment of credit within the stipulated time, one could lose the asset
3. The repayments of loans are not very flexible as the criteria are determined by the lender that is the bank or the financial institution as the case may be

Pros and cons of choosing an overdraft facility

The choice of an overdraft facility depends upon the financial needs of a person. 

Some of the pros or advantages of using an overdraft facility are –

1. There are options available for borrowing and repayment which are flexible
2. The borrower is free to decide the amount of money payable each month 
3. Overdraft is an option which is cheap enough for borrowing for a short term since the interest may not be charged on it

A few cons or drawbacks of availing an overdraft facility are – 

1. The sum of money withdrawn is less than a loan for personal use
2. The interest or fees on overdrafts can be charged higher and even more in case if the agreed limit crosses over, thus making it very expensive for borrowing

When it comes to business loan vs overdraft, Both the financial products have their own set of benefits and drawbacks at the customer’s disposal. With minimum documentation as well as a hassle-free process, the customers can avail of any credit facility that suits them best according to their requirements.