Business line of credit vs overdraft: the difference

Lines of credit and overdrafts get mixed up all the time, by clients and sometimes by lenders' own marketing. They solve the same problem, which is uneven cashflow, and they work in a similar way. The differences are in where the facility sits, how it's drawn, what secures it and how it's reviewed.

What they have in common

Both are revolving facilities. The business gets an approved limit, draws what it needs, repays and can draw again. In both cases interest is generally charged on the amount used, not on the full limit. That makes them suited to working capital: paying suppliers before customers pay, covering wages in a slow month, or buying stock ahead of a busy season.

Neither is usually the right tool for a one-off long-term purchase, such as buying a business or a large piece of equipment. A term loan or asset finance is normally a better fit for those.

Business overdraft

A business overdraft is attached to the business's transaction account. NAB describes it as "linked to your business transaction account", with the business able to draw on it as needed up to an approved limit, paying interest only on the amount used. NAB also notes that costs may include facility or account fees, and that additional charges may apply if the limit is exceeded (NAB).

In practice:

• The account balance simply goes below zero, up to the limit. There's no separate "draw" step.

• Overdrafts are mostly a bank product, because they sit on a bank transaction account.

• They are often secured, commonly by property, especially for larger limits.

• Facilities are typically reviewed periodically. Check the terms for the review date and the circumstances in which the lender can reduce or cancel the limit.

Business line of credit

A business line of credit is a separate facility. The business draws funds into its own transaction account, which can be with any bank, then repays into the facility.

In practice:

• It's offered by banks and by many non-bank lenders.

• Non-bank lines of credit are often unsecured, or secured by a general security agreement over business assets rather than property.

• Draws are usually made online, with funds arriving in the business's account.

• Some lines require each draw to be repaid over a set period, rather than leaving the balance open-ended. Others charge a fee per draw, or a fee on the undrawn limit.

• Limits and terms vary widely, so the product guide matters.

Side by side

This is a general comparison. Every lender's product guide is different.

Questions to ask before choosing

Does the client want to keep their current bank? An overdraft generally comes with the transaction account. A line of credit can sit alongside any bank.

What security is available? If the client has no property, or won't use it, an unsecured or lightly secured line of credit may be the realistic option.

How will they actually use it? A business that dips in and out daily may prefer the seamless overdraft. A business that needs a lump sum every few months may suit a line of credit, especially if each draw has its own repayment schedule.

What does it really cost? Compare the interest on a realistic drawn balance, plus every fee: establishment, ongoing, per-draw, undrawn line and limit excess fees. Some products look cheap until you model how the client will use them.

How is it reviewed? Ask how often the facility is reviewed, what the lender looks at, and what happens if the business's trading changes.

Where this sits in lender policy

Whichever product fits, lender policy decides who will actually offer it to the client: minimum time in business, minimum monthly turnover, credit history, industry and existing debt. Lines of credit in particular vary a lot between non-bank lenders. Our guide How SME lenders assess a deal walks through those criteria.

Visro shows, for a given scenario, which lenders on the panel offer each product and whether the deal fits their policy. You can see which lenders offer lines of credit and overdrafts on the lenders page.

The short version

• Both are revolving working-capital facilities with interest on what's used.

• An overdraft sits on the transaction account and is mostly a bank product, often secured.

• A line of credit is a separate facility, common with non-banks, and is often unsecured or secured over business assets.

• The right choice depends on banking relationship, security, how the client will draw it, and the total cost including fees.

Sources

• NAB: Business loan vs overdraft

This article is general information only. It isn't legal, financial or credit advice and doesn't take into account anyone's circumstances. Product features vary between lenders and change over time, so always confirm details with the lender. Visro does not provide credit assistance or financial advice.