In the corporate world, both big and small businesses require funds from time to time to fulfil financial obligations, such as covering daily operation costs, paying salaries to employees, and upgrading equipment. This is where the role of business loans comes in.
Two of the most popular variants of business loans include term loans and overdrafts. This article will cover what a term loan and overdraft are, state different aspects related to them and list the difference between overdraft and term loan. Let us dive right into it:
Overdraft Loan Or Term Loan – A Detailed Explanation
Term Loan
A term loan is defined as a type of loan that the borrower needs to pay back to the lender within a fixed period. Like most other types of loans, borrowers of term loans also need to pay interest. The interest rate depends on the market’s fluctuation.
Moreover, similar to the acquisition procedures of other types of loans, individuals also need to g through a documentation process to acquire a term loan. However, the entire process is simple and hassle free.
Term Loan for Small Businesses and Individuals
Since term loans can be taken for longer periods, the borrower can use the sanctioned amount for numerous business-related purposes. For example, business owners can use term loans to expand their business, purchase better machinery & raw material, pay rent of the office premises, clear bill payments and employees’ salaries, etc.
Eligibility Criteria
Individuals looking to acquire a term loan must fulfil the following criteria:
- The applicant must have an excellent credit score.
- They should have a steady source of income.
- At the time of applying for a term loan, the applicant’s age should not be less than 21 years or more than 65 years.
- They should meet the turnover criteria of the lender or lending institution.
- Their business should be profitable for the last 2 years.
- They should have all the documents the bank requires to process the loan application.
Documents Required
Even though different lenders require different documents, here are some common ones that every bank or lending company asks for:
- Proof of Business Registration.
- Applicant’s and their business’ KYC documents.
- Last 9 months’ financial statements.
- Promoter’s PAN Card
- Promoter’s Aadhar Card.
Advantages of Taking Term Loans
Some of the most prominent advantages of opting for a term loan are:
- The majority of the term loans feature a longer repayment period, which is why they feature lower interest rates as opposed to short term loans.
- If the lender permits, borrowers can choose to return the borrowed amount through easy monthly instalments or EMIs.
- Most term loans offer a high amount of funds to borrowers, which they can use to improve their business growth.
Disadvantages of Term Loans
Here are two major disadvantages of term loans:
- If the term loan acquired by an individual features a short repayment period, it will have a higher interest rate.
- As opposed to other forms of loans like overdrafts, the loan amount cannot be changed or modified. Hence, the borrower can only avail of the fixed amount of funds sanctioned by the lender.
Overdraft Loan
Overdraft refers to a facility where individuals can withdraw money up to a specific limit even if their bank account‘s balance is zero. The overdraft facility is deemed a short term loan featuring a short repayment tenure.
The form of credit facility can be availed of by individuals both on a secured as well as an unsecured basis. Similar to term loans, individuals who wish to acquire an overdraft loan need to provide certain documents during their application process to get the sanctioned loan amount. Only current account holders can apply acquire overdraft loans.
Individuals with good credit limits can apply for overdraft loans through banks. However, the process is very lengthy and time consuming. This is why most people prefer using reliable online platforms over other financial institutions to apply for term loans, overdraft loans, or any other kind of loan.
One of the most trusted and renowned platforms using which individuals can easily apply for different types of loans and acquire funds is Yubi Loans. Boasting over 3000 active borrowers, the popular platform features 750+ trusted lenders, each of which offers the best terms and benefits. Moreover, the platform offers 5x quicker transaction time, which further adds to the borrower’s convenience. These are some of the main reasons why Yubi Loans is the perfect outlet from where business owners can avail of any sort of credit facility quickly and efficiently.
Advantages of Overdraft Loan
Some of the main advantages of acquiring overdraft facilities are:
- As opposed to term loans, overdraft requires significantly lesser paperwork. They also feared a less-complicated document verification process.
- If an individual’s business has met with a hefty loss or incurred a high expense, it can be met through an overdraft loan. Hence, it is safe to opt for it during busy business periods.
- Overdraft facilities offer top-tier flexibility to borrowers in terms of the amount disbursed.
- Most overdraft loans are unsecured, i.e., they do not require individuals to pledge any security as collateral.
- The process of availing of the overdraft facility is hassle-free since it fulfils minor fund requirements of businesses.
Disadvantages of Overdraft Loans
Two major disadvantages of overdraft facilities include:
- Business owners cannot use overdraft loans to fulfil major business expenses.
- Many types of fees, such as an arrangement fee, are involved in the case of overdraft loans.
Differences Between Overdraft Loan and Term Loan
| Parameter | Overdraft Loans | Term Loan |
|---|---|---|
| Meaning | It is a facility using which individuals can access and withdraw funds from their current account even if their balance is zero. | It is a type of loan wherein users receive a fixed amount of money for a fixed period. |
| Security/Collateral | No security or collateral is required. | Depending on their type, term loans may or may not require security or collateral. |
| Process | It is a one-time process, i.e., availing an overdraft loan does not involve tons of paperwork. | Applicants need to go provide minimal documentation. Moreover, the disbursal of funds is also very convenient. |
| Time | Overdraft loans are short term loans. | Term loans may be short term, long term, or intermediate-term loans. |
| Usage | Used for fulfilling working capital requirements. | Used for expanding businesses, upgrading machinery, etc. |
| Rate of Interest | The interest rate is charged only on the used amount. | Interest is charged on the entire borrowed amount. |
| Interest Calculation | The interest rate is fixed | The interest rate varies and thus, it is calculated monthly. |
| Current Account Holder | Current account is not mandatory. | Current account is mandatory. |
| Repayment | Repayment of the borrowed amount is made through bank deposits. | Repayment of the borrowed amount is made as per the lender’s requirements, or in the form of EMIs. |
| Credit Facility | Overdraft loans are offered by different financial institutions, each of which have their own set of rules and regulations and interest rates. | Term loans are also a form of credit facility wherein the terms & conditions, and the interest charged depend on the lending company. |
| Limit | The limit of the sanctioned amount depends on the borrower’s credit limit. | The limit is fixed. |
FAQs
What are some of the key considerations which decide the rate of interest on term loans?
The lending company or bank determines the interest rate charged on a term loan after considering numerous factors, such as the loan amount sanctioned, its tenure, the type or sector of business for which the applicant needs the loan, etc.
Other important factors include the project’s cash flow, borrower’s debt status, existing leverage, etc.
What are the different options available when it comes to term financing?
Depending on their repayment tenure, term loans are categorised into multiple categories. The categories include a short-term loan, which is generally given to individuals for less than 12 months, an intermediate-term loan, which features a repayment tenure between 12 and 60 months, or a long-term loan, whose repayment period lies anywhere between 5 and 25 years.
Which are the types of businesses that can get term loans?
Companies belonging to any sector are eligible to receive term loans. Besides companies, startups and sole proprietorship businesses can also apply to acquire a term loan.
What is the importance of credit rating, and how is it determined?
The credit rating or credit score of the individual plays a crucial role when they are applying for any loan.
Official agencies and companies like TransUnion and Equifax provide credit or CIBIL scores to lenders. On the other hand, companies like ICRA, CRISIL, and CARE provide credit ratings to companies.
How is the term loan interest rate linked to external benchmark rates?
In certain term loans, the interest rate charged is associated with external benchmarks such as the Repo Rate, LIBOR, MCLR, MIBOR, etc.
What are the documents needed while applying for a term loan?
Even though it varies from lender to lender, the generic list of documents every lender asks for includes the audited bank statements of the past 3-5 years, Aadhar card, PAN card, current account statement of the past 6 months, IT returns, etc.
