The news that overdraft interest rates are set to skyrocket from April 2020 onwards is giving everyone pause for thought, raising the question: is it cheaper to get a loan or an overdraft?
The change in overdraft costs is happening because the Financial Conduct Authority (FCA) discovered that banks were reaping huge profits from them. But the enforced change to a fixed rate of interest has led to many banks charging 40 per cent – around double the cost of many credit cards.
The FCA claims that seven out of 10 overdraft users will see no change in what they pay for their overdraft or be better off, and say that the new rules only affect personal banking rather than business accounts.
But the shake-up has nevertheless prompted businesses that rely on overdrafts to assess their options. After all, a bad credit score brought about by missed personal overdraft payments could affect your chances of getting a business loan. Where, then, do business overdrafts slot into the small-business finance equation?
If you're contemplating whether a business loan or overdraft facility is better suited to your company's needs, the following pros and cons are worth keeping in mind.
A business overdraft works in much the same way as a personal one, allowing companies to access funds even when their account balance drops to zero. Business overdraft rates are typically linked to the Bank of England base rate on a variable or tracker basis.
The benefits and advantages of a business overdraft include:
There are, however, a number of disadvantages to a business overdraft, including:
Business loans differ from overdrafts in that they represent a single, capital sum that is repaid in agreed instalments over a set period of time. There are various types of business loan; the main two being secured and unsecured, and you can take out an amount of money that suits your company's needs.
The main advantages of a business loan when compared to an overdraft is that they generally grant access to a much larger sum of money. With more funds, you could look to:
As a loose guide, business loans often don’t come with costly set-up fees, whereas many business overdrafts do. With overdrafts, the bank can request repayments immediately and without warning- whereas typically with business loans, your monthly repayment schedule is more predictable.
A potential downside of a business loan is the possibility of not having your application accepted. The minimum amount of money you can take out with a business loan is often much higher than an overdraft, too, so businesses that only require extra funds to cover a small seasonal trough in cash flow might opt for an overdraft.
Bank overdrafts have long been seen as a reliable safety net, but in the current economic climate many businesses view loans as a safer, more predictable option.
When weighing up whether a business overdraft or loan might suit your needs better, it is important to take into account your business credit score, your cash flow and the purpose for which you intend to use the overdraft or loan.
Once you have these factors clearly established, you are ready to start exploring your options- and look for a quote.