Advantages and disadvantages of overdrafts
An overdraft is a borrowing facility attached to your bank account, set at an agreed limit. It can be drawn on at any time and is most useful for your day-to-day expenses as it can help you to manage your cashflow more flexibly.
It is worth noting that loans are probably more appropriate for long-term funding. An overdraft is likely to cost more than a loan for a long-term purchase.
Advantages of an overdraft
- An overdraft is flexible - you only borrow what you need at the time which may make it cheaper than a loan.
- It's quick to arrange.
- There is not normally a charge for paying off the overdraft earlier than expected.
Disadvantages of an overdraft
- If you have to extend your overdraft, you usually have to pay an arrangement fee.
- Your bank could charge you if you exceed your overdraft limit without authorisation.
- The bank has the right to ask for repayment of your overdraft amount at any time, although this is unlikely to happen unless you get into financial difficulties.
- Overdrafts may be secured against business assets.
- Unlike loans you can only get an overdraft from the bank where you maintain your current account. In order to get an overdraft elsewhere you need to transfer your business bank account.
- The interest rate applied is nearly always variable, making it difficult to accurately calculate your borrowing costs.
- Unutilised overdraft facilities may be reduced by the banks at short notice, although this is unlikely to happen unless you get into financial difficulties.
Bear in mind that what starts out as a good deal may change - as may your business needs. It's worth reviewing your options regularly.
If you believe that getting an overdraft may be a viable option for your business, see prepare your business for bank financing.