Business Loan or Overdraft - Which is Better?

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. 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.

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.

Comparison between a business loan and overdraft facility

Points for Comparison

Business Loan

Overdraft

Definition

An unsecured loan or a fixed loan amount which is borrowed for a specific period, against a collateral (in case of a secured loan) and is repayable along with interest through EMIs

An amount that can be withdrawn even in case of zero bank balance in the account

Type of Loan

It is a Borrowed form of Capital

It is basically a Credit facility

Rate of Interest Charged

On sanctioned amount of loan

On amount withdrawn

Availability

As a loan for Long-term

 As a fund for Short-term

Method of Repayment

By way of EMIs

From the deposits in the bank

Calculation of Interest Rate

Monthly Basis

Daily Basis

Amount of loan or Borrowed Funds

It depends on the business requirements, the applicant’s profile, applicant’s credit score, etc.

It depends on the amount of money present in the current account, in relation to bank

Should the applicant be an account holder of the bank?

No, it is not necessary to be the account holder

Yes, the borrower must be an account holder

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 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 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

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.

Business Loan or Overdraft – Which is Better? FAQs:

1. What are the eligibility criteria for availing the facility of the overdraft loan?

The following are the eligibility criteria – • The applicant should be of the age group of 22- 58 years. • The applicant’s minimum monthly income should be ₹35,000 • The applicant should be continuing the same job for the past six months • The applicant should have a minimum of one year of work experience

2. How will the amount of loan be disbursed?

At the time of the first disbursement of the loan amount, the time of limit setting along with the charges such as PF plus stamp duty plus insurance will be deducted from the requested loan amount, and the remaining amount will this be sanctioned and transferred to the registered bank account of the borrower. The customer has to pay plus stamp duty and the insurance, and his limit will be restored after a stipulated period.At the time of the second disbursement or withdrawal, the borrower can raise a request for the drawdown and post paying off all the charges. Disbursement is made either on the same day or the next working day depending upon the banking hours into the registered bank account of the customer.

3. When is interest on loan generated?

The interest on the loan is generated on 30th or 31st midnight of every month. The borrower is informed regarding the interest amount on the first of the month through a mail or an SMS

4. What is the rate of interest, as well as the processing fee on business loans?

Interest incurred on the business loans varies from 16% to 23%, and the processing fee is up to 2.5%. Additionally, some banks insist on buying an insurance cover also.