Business overdraft facility explained
A business overdraft facility allows you to access business credit quickly and easily from your existing accounts, but how does it work? What are its pros and cons and how do I measure one against another to find the best? Learn about business overdrafts and how to compare them with this guide.
What is a business overdraft facility?
A business overdraft is a form of business credit where a lender sets aside a certain amount of funds for your business to use as they’re needed. It has similarities with a credit card or a line of business credit, with some of the same advantages and disadvantages. A business overdraft is attached to an existing financial account, such as a savings or transaction account with a bank. Once it’s set up and approved, it allows your business to continue withdrawing money from your account even after the balance has reached zero.
A business overdraft facility can potentially offer a substantial amount of funds. The limit on any given account will be set by the lender while you’re applying for the overdraft facility, but it’s possible for an unsecured business overdraft to offer in the area of $100,000. If you’re willing and able to offer security on the overdraft facility, though, this amount can be much larger – potentially into the millions.
How do I compare a business overdraft facility to another?
When it comes to comparing one overdraft against another, there are a few things to weigh up. For starters, as a business overdraft is a facility attached to an existing account, there’s obviously a convenience factor to setting up the overdraft on the account you’re already using. However, if you’re looking to set up a brand-new account for the overdraft facility, or you’re willing to change account, there are several factors that are worth considering as you compare your options.
- Secured or unsecured – Does the overdraft require securing, or is an unsecured overdraft an option? Some lenders will only offer a secured overdraft if you’re not an existing customer, for example.
- Interest rate – The interest rate can make a big difference to what you pay on a business overdraft – especially if you need to use a large amount of credit or you’re not able to clear the debt promptly. Be careful, though: the advertised rate that lenders show on their website might not be the exact interest rate you’re offered on an overdraft, as it’s intended as a reference only. Providing security for your loan will lower your rate.
- Credit limit – Different lenders may offer different credit limits on an overdraft. The financial situation of your business can influence this and secured credit lines will normally offer much higher credit limits.
- Fees – Different lenders charge very different fees. Some might have no setup cost, but charge a higher annual fee (which is often calculated daily, despite the name). Others might have a higher application fee but charge less per year. Also, some might not openly advertise some fees, simply saying you can find the cost “on application”.
Pros & cons of an overdraft facility
Simple application process
The application process for an overdraft facility is similar to that of a loan application, but can often be completed more quickly. For many lenders, it’s simply a matter of logging onto their website and applying through your account. Of course, if you don’t have a business account with your lender of choice, you’ll need to open one.
An overdraft facility is a very flexible way to access money. You can draw on your credit at any time, without any additional approval needed. You can also repay the money as funds are available, making an overdraft facility very handy if your cash flow fluctuates.
Can be used for almost anything
There are very few restrictions on what you can use the money from a business overdraft for. While you need to provide a lender with details of exactly what you intend to use loan funds for, there’s no such restriction on an overdraft facility, so it can be used on bills, wages, equipment upgrades, special events or expenses to boost staff morale. You do need to use it for your business and not for personal reasons, though, otherwise you’re breaking the terms of your overdraft agreement.
Can be cancelled at any time
Trying to settle a loan early can be something of an arduous process. An overdraft facility can be shut down at any time – provided you don’t currently have anything owing on the account.
Significant fees for going over the limit
If you spend more than your limit on an overdraft facility, you can potentially be hit with some pretty hefty fees, so it’s a good idea to keep a careful eye on your expenses and your account balance once you’ve dipped into your credit.
Higher interest for long term debt
While you only pay interest on the money currently in use, the interest rate on an overdraft facility is generally quite high. This means that if you find yourself caught out by debt and struggling to repay the overdraft, you’ll be paying more significant interest on that debt.
More impact on credit score
As mentioned, a business overdraft facility is a kind of credit. As such, how you use it has a significant impact on your business’ credit rating. This means you might not want to make your limit on the overdraft too high. It’s also wise not to use more than a third of the credit you have available.
Temptation to overspend
Sometimes having the option of going easily into debt can be an unhelpful temptation. While running out of money can force a business to make necessary hard choices or find alternative sources of funding, having the option to easily borrow money can potentially land you in substantial debt by overspending a little at a time. It can also give you a false sense of security about your financial situation.