How does a business overdraft work?
Like a personal overdraft, a business overdraft effectively lets you borrow money as and when you need it in exchange for an interest fee. It’s effectively a type of revolving credit facility, letting you borrow and pay the debt off as you go.
Overdrafts are a short-term form of lending and are only really recommended for emergencies – for example, to give you a bit of breathing room in case your account goes into a negative amount.
In the same way as you would with your personal overdraft, you should pay your business overdraft back as quickly as you can.
What are the types of overdraft?
There are two main types of business overdraft:
- Authorised – With an authorised overdraft, you agree an amount that you can borrow up to. You’ll still pay interest on the amount you borrow from your overdraft, but the interest is usually lower.
- Unauthorised – An unauthorised overdraft works in exactly the same way, except that the amount you borrow isn’t pre-approved by the bank. Unauthorised or unplanned overdrafts can often come with much higher interest rates, and you may even incur additional fees too.
What are the interest rates?
The interest fees vary from bank to bank and from account to account. The amount of interest you’ll pay is also different for authorised and unauthorised overdrafts. As overdrafts are a form of short-term lending, the interest rates can usually be quite high.
As well as an interest rate, which is based on the amount you go into your overdraft by, you may also have to pay an additional fee.
What are the benefits of a business overdraft?
Business overdrafts give you the flexibility of knowing you’ll be able to borrow money for short-term purposes, particularly to account for cash flow fluctuations. Another big benefit of a business overdraft is that you’ll only pay interest when you borrow.
In most cases, you won’t need to offer collateral to get a business overdraft. However, if you’re asking to borrow a large amount, the lender might put a charge (otherwise known as a debenture) on your business.
What are the disadvantages of a business overdraft?
The main disadvantage is that the interest rates can be quite high, meaning they’re only really good for emergencies and temporary cash flow shortages.
If you need to borrow money for a specific purpose and for a longer period of time, you may be better off with a small business loan.