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Choosing the right loan type for your business

If you need finance for your business and you’re not sure whether to choose a business term loan or overdraft, there are a few ways to discover which could work best for you.

3 minute read

If you’re like many small business owners, then at times you may need an injection of cash. It could be to solve a short-term cash shortage or to help you plan ahead. Sometimes the big question is deciding if you need a term loan or overdraft.

Identify your needs

Term loans are often used for things that are not part of your regular cash cycle, for example:

a new vehicle
more equipment
money to expand operations
a supplier has discounted significantly and it’s worth buying additional stock.

Overdrafts are usually for things that crop up unexpectedly week to week, interrupting your cash flow, for example:

sudden bills that are due and you can’t put off
providing cashflow when you are waiting on invoices to be paid, or cash to reach your account.

Fixed or flexible terms

A term loan has a start and a completion date. Once you’ve decided the amount and the term (length of time you have to repay the loan), you’ll need to set up a regular repayment plan (interest and principal). Payments stop once it’s all repaid.

An overdraft is a facility you set up with no official completion date. You set an agreed limit which stays in place (even if you don’t use it) for whenever there’s a need. You only pay interest when you dip into it, and you can repay the balance at any time. There is also a monthly overdraft facility fee.

Planning in advance vs having a safety net

A term loan is often used to pay for something you’ve planned in advance, where you don’t have the money available or you prefer not to spend your cash reserves.

If you need to buy a new asset, it can often be easier to take out a term loan over a number of years to spread out the repayments. The alternative is to buy the asset outright, which is fine if it doesn’t place any financial stress on your working capital.

An overdraft is back-up, like an insurance policy that provides funds only when you need it. If you require funds on a particular day, you can use your overdraft to cover any shortfall and it’s always there.

Both help you save your own money

Term loans and overdrafts are useful if you don’t want to spend more of your own money. If you do need extra cash, one option is to use personal funds (savings). But it’s not always practical especially if there is more than one owner in the business, where one has the capital and the other doesn’t.

The difference in repayments

Term loans have interest rates with identical, regular repayments across a fixed term. A term loan will allow you to have a slightly lower interest rate than an overdraft. Keep in mind that term loans are recorded as long-term debt on your balance sheet.

You’ll be charged interest on the amount outstanding under your overdraft. If you don’t use your overdraft you will not be charged interest. Overdrafts do have slightly higher interest rates than term loans. They’re recorded as short-term debt on your balance sheet.

The right loan type for your business

Either could be right, depending on your circumstances. Your business needs and priorities can change over time, which possibly affects the loan that is right for you. Some businesses have both for different reasons which is also perfectly fine.

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Term loan or overdraft?

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Our business loans are subject to lending criteria, terms and fees (including overdraft establishment fee and overdraft facility fee).

The information in this article is provided for general purposes only, and is a summary based on selective information which may not be complete for your purpose. To the extent that any information or recommendations in this article constitute financial advice, they do not take into account your financial situation or goals and is not intended as personalised financial advice. While BNZ has made every effort to ensure that the information provided is accurate, you should not rely on this information to make any financial decision without first having sought advice specific to your circumstances from an authorised financial adviser. Neither BNZ nor any person involved in this article accepts any liability for any loss or damage whatsoever which may directly or indirectly result from any advice, opinion, information, representation or omission, whether negligent or otherwise, contained in this article.