The 2 types of loans that most businessmen would take when they are short of working capital is an overdraft or a term loan. Both are easily obtainable if you have some assets that you can use as collateral. However there is a slight difference in these loans.
Overdrafts
Overdrafts can be approved within 2 days if you have a fixed deposit account with the bank that you are applying for that loan. By using your money in your fixed deposit account as a collateral, you can use up till 90% of what you have in your account. The banks wins all the way if you are wondering. The interest you pay for using your own money is higher than the interest that the bank is paying for the fix deposit. If the fixed deposit rate is 4 %, overdrafts interest will be something like 5.5 % or 6 % depending on the banks. What you can take as consolation is you are only actually paying 1.5 or 2 %.
Overdrafts are very useful for business that has a big turnover. There is no time limit for you to pay back. As long as your collateral is with the bank, you can take as long as you want to repay. Banks will not chase you for the money that you have used because it is actually your money. As long as you serve your interest every month they are very happy. Since there is no fixed amount that you have to pay other than the monthly incurred interest, most businessman never sees paying back the principle as a main priority. So they will keep paying interest year after year.
Like I mentioned, you can pay back your overdrafts any time you like, that’s why it works best for businesses with a big turnover. Say you have laid hands on a big project that is worth $ 500,000 and the project needs $50,000 for you to get started. Getting an overdraft is the best choice. Once progress payments start to roll in after a few months, you will have the money to pay back the overdraft and you save considerable interest.
Term Loans
For business where turnover is small and almost fix without much fluctuations, a term loan will be an better option. Term Loans require you to pay a fixed amount monthly, so you can easily work out a budget if your turnover is stable every month. It like a kind of forced pay back. So if you take a term loan for 5 years, you will be loan free after five years, which will be a very good sign.
If you have opted for an overdraft, you might be stuck with the loan for 10 years because there is no compulsory pay back period.