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Bank loans and overdrafts

Author: Jim Riley  Last updated: Sunday 23 September, 2012

Finance - Bank Loans and Overdrafts

Bank Loans and Overdrafts

A bank overdraft is a limit on borrowing on a bank current account. With an overdraft the amount of borrowing may vary on a daily basis.

A bank loan is a fixed amount for a fixed term with regular fixed repayments. The interest on a loan tends to be lower than an overdraft.

Example of a loan:

A business borrows £12,000 from a bank over 3 years at an interest rate of 5%. The approximate repayments on this loan would be £392 a month for 36 months (£14,112).

A fixed term means how many months or years before the loan has to be repaid in full.

Normally a fixed term loan will be for a greater amount than an overdraft.

 

Overdrafts

Loans

Advantages

Flexibility – can change the amount borrowed within limits

Interest is only paid on amounts borrowed

Larger amounts can be borrowed

Lower interest rates than overdrafts

Regular repayments help plan cash flow

Disadvantages

Cannot be used for large borrowing

Rates of interest higher than loans

Bank can change limit at any time or ask for money to be paid back sooner than expected

Less flexible than an overdraft

Have to pay back in stated time or risk further financial problems

Debentures

A debenture is a long term loan which is usually secured against a specific asset (e.g. the factory) or the overall assets of a business. A debenture is repayable at a fixed date and has a fixed rate of interest.

Debentures are different from ordinary shares because:

The lender has no voting rights in the company.

The loan attracts interests – whereas holders of ordinary shares get dividends.

The providers of loans are paid out before ordinary shareholders in the event that the business fails (assuming there is some cash left).



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