What is an overdraft?
An overdraft is a feature of many transaction bank accounts which allows you to continue to draw funds from the account even if the account has a zero balance. Often an overdraft will have a pre-determined limit which dictates how much you are able to continue to draw from the account after its balance hits zero.
An overdraft acts much like a line of credit in that interest is charged on any amount that is drawn of the overdraft amount and it can be repaid back and drawn down at any time. The key difference is that it is often linked to a transactional bank account. If the account balance is below zero and the overdraft is being used, the account is said to be ‘overdrawn’.
Overdrafts limits can start at anywhere from $2,000 to $5,000 and if secured with collateral, can go up to over $100,000 with the maximum limit subject to lender approval.
Benefits of an overdraft
Like a line of credit, an overdraft is an open line of funds that can be drawn and paid back at any time. This is great because with an overdraft you can have the peace of mind that whenever you need new funds, whether it be for unexpected costs or brand new opportunities, they are available and ready to go. No more going back to the bank to take out a new loan every time!
Drawbacks of an overdraft
Whilst overdrafts can provide great flexibility to your business, lender’s will often require a couple of years of trading before they will approve an overdraft.
There is also the chance that the overdraft may have a ‘repayable on demand’. This means that the lender can demand that you pay back any overdrawn amounts at their will. This can really pull the rug out from under you so it’s a good idea to be fully aware of all the terms and conditions of your overdraft!
One thing to watch out for are the different fees involved with an overdraft. These often include an upfront application fee as well as annual ‘maintenance’ fees. Many lenders provide overdrafts that don’t charge any upfront fees so it pays to shop around and explore your options.
Applying for an overdraft
Applying for an overdraft is similar to applying for most other loans in that you likely have to provide business bank statements in addition to business financial statements.
When applying for an overdraft be sure to ask for any application fees (if there are any) as well as if there are any other ‘facility fees’. This could include an ongoing fee charged by the lender for having the fund ‘in reserve’ for you in the form of the overdraft. Be sure to always ask for a thorough explanation of all of the terms and conditions included in your overdraft agreement too.
What is the best way to use an overdraft?
Overdrafts are best kept as reserve funds to help smooth out the ups and downs of cash flow over time. Whether the funds are used to pay for unexpected expenses or fund a new growth opportunity, that is entirely up to you. The only thing would be to be careful of where your limit is and to only use the overdraft when you are comfortable that you will be able to pay back the amount you draw down in the future so you aren’t stung with large interest bills.