Businesses often find themselves short of funds. An overdraft facility is taken to help small-scale businesses flourish. This facility assists them to cover expenses despite their low bank balances. An overdraft is understood as a famous credit facility among current account users. Typically, there is a cost to using arranged overdrafts that is known as interest charges.
As reported by LendingStream, about 1 in 5 adults said they use their bank overdraft every month. This potentially happens because people are unaware of the usage of overdraft facilities. You must be well-versed in the benefits and drawbacks of overdraft facilities.
A drop-line overdraft is a loan where the credit limit is reduced periodically. For example, a business secures a₹10 lakh overdraft, but the limit drops by₹1 lakh each year. After five years, the limit is zero. The borrower repays gradually as the limit decreases.
Advantages of using overdrafts
There are several advantages linked to an overdraft facility. Its convenience and flexibility are the top two benefits so far. Following are the advantages you gain when using overdraft loans.
Easy application process |
The application process is simplified and pretty straightforward. The existing account users must submit an overdraft application to their banks. The bank then decides on the overdraft limit after reviewing the current debts. Credit history is also responsible for setting an overdraft limit. It’s influenced by the account balance and other financial factors. Oftentimes, a bank will provide an interest-free buffer. |
Flexibility |
Flexibility is a significant parameter you must consider. An overdraft facility is known to be one of the most flexible credit options. The facility remains precisely available to you. It can be used whenever it is needed, unlike a loan or credit card. Overdraft facility provides a flexible repayment term. |
No charges for early repayment |
Most credit options have a fixed repayment schedule. A prepayment charge is to be paid if you wish to pay a loan ahead of schedule. There are no repayment deadlines. Therefore, banks do not charge any fees for early repayment. You are free to pay it back whenever you have the adequate funds. |
Disadvantages of using overdrafts
As every coin has two sides, there are disadvantages linked to overdraft facilities. You must be careful while availing of an overdraft loan. Some of the drawbacks are enlisted as:
Low borrowing limits |
It is one of the most useful ways of borrowing capital. However, it cannot replace a regular business loan. The borrowing limits of an overdraft facility are significantly lower than loans. An overdraft would be able to cover your operational expenses. However, if you need a huge amount of funds, say to get new machinery for your business. During such times, bank overdrafts cannot be of much help. |
High interest rates |
Bank overdraft facilities are convenient, but they don’t come without a cost. Banks charge high interest rates on overdrawn amounts. In fact, in 2020, the Financial Conduct Authority had to intervene. It asked the banks to explain their high overdraft rates. Banks were charging interest rates as high as 40% on overdrafts at the time. Currently, the interest rate on an overdraft can range from 19% to 40%. |
Possibility of reduction of the limit |
Your overdraft credit limit is controlled by your bank. The bank can reduce the limit according to the circumstances. Such as if you have too low of a current account balance. |
The conclusion
To sum it up briefly, overdrafts can be advantageous for businesses with short-term financial requirements. It is a convenient and flexible credit option, particularly at times of crisis. However, it is to be known that no line of credit is perfect. Even an overdraft facility has some drawbacks and risks. You must be pretty considerate while choosing an overdraft for your business. It can generally be expensive due to increased interest rates.
