Confused between business loan and overdraft?

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Most organisations, regardless of their nature, size, or industry need to borrow funds at some point of time. Whether it is for growth, expanding operations, or to weather an uneven patch, borrowing is an important and crucial part of running a business.

The type of credit options available to you can be bewildering, particularly if it is the first time that you are borrowing for your company. One of the common questions you may ask is, “Which loan option should I opt for – overdraft or business loan?” The answer is not very simple. The correct credit option depends on your company’s financials and your requirements.

To help you understand better, here is a comparative analysis of the two common business financing options – business loan and bank overdraft.

Usage: A business loan may be a secured or unsecured loan that can be availed for different business purposes such as business expansion, to meet working capital requirements, to buy property or land, to buy machinery or plant, to train employees, to enhance inventory, etc. Overdraft, on the other hand, is a credit option that permits you to withdraw money from your bank account even if your current account balance is nil. This means, you can borrow over and above your current account balance. The option is best to meet your short-term business needs such as paying wages, buying raw materials, etc.

Also Read: What is MSME Loan? Benefits & Eligibility

Loan amount: If you are looking for a huge amount then a business loan is a better option. An overdraft is best suited to meet short-term funding requirements. A predetermined credit limit is offered on overdraft options, which you can withdraw bit by bit, at any time, based on your requirements. In the case of business loans, a huge loan amount can be availed in a single shot.

Rate of interest: Usually, the interest rate on overdraft options is higher than business loans. However, in the case of overdraft, interest is levied just on the amount that you withdraw and not on the whole overdraft limit available to you. On the contrary, in the case of a business loan, interest is levied on the entire loan proceeds you borrow, regardless of whether you use it.

Duration: An overdraft is disbursed for a short duration of usually one year. You must renew it towards the end of the repayment tenure if you need the facility for the next year. In the case of business loans, they are usually available for a longer repayment tenure, say up to 25 years, based on the lender’s criteria.

Features	Overdraft	Business loan
Definition	This is a facility where you can withdraw an amount over and above your current account balance. The additional amount that you borrow through the overdraft option is fixed up to a predetermined limit	This is a fixed amount offered by lenders. It must be repaid within a predefined repayment tenure along with the interest component
Product nature	Credit line	Borrowed capital
Ideal for	Short term fund requirements	Long term fund requirements
Interest levied	On the amount withdrawn from the overdraft credit limit	On the loan amount disbursed
Interest calculation	Daily basis	Annual or monthly basis
Repayment	In the form of deposits in the current account	In the form of Equated Monthly Instalments (EMIs)
Bank account	You must have a current account to avail this facility	Not necessary to have a current account or any type of account with the lender

Also Read: What is Account Aggregator: A Comprehensive Overview

Ending note

Business loans are prudent for long-duration planned purchases. On the other hand, an overdraft is ideal for short-duration requirements as through it you can increase your working capital and boost your cash flow. While both are variants of business credit, they serve distinct purposes. You can choose an overdraft, a business loan, or even both based on your business and cash needs.

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Disclaimer: This Article is for information purposes only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. The Bank makes no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Article. The information contained in this Article is sourced from empanelled external experts for the benefit of the customers and it does not constitute legal advice from the Bank. The Bank, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.