Bank Loans and Overdrafts as Business Finance
Using bank loans and overdrafts are two of the most common types of finance used by small businesses. Yet a surprising number of businesses are still failing to get the best deal from bank finance, and many are finding they could get a better deal through other forms of finance.
Here is a detailed look at bank loans and bank account overdrafts, helping you to decide whether they are the right kind of finance for your business.
Bank Loans
If you asked most new business people how they expect to get finance, the vast majority would say ‘a business loan from the bank’. The routine of new business owners going to the bank with their business plan in hand and trying to persuade the bank that the idea is a profitable one has changed very little over the past 30 years.
How Do Bank Loans Work?
Bank loans work in much the same way as secured personal loans, the bank lends you money, with repayment over a set number of years at a particular interest rate.
The loans are usually secured against your house or other personal and business assets (e.g. Expensive machinery); so if you cannot pay them back your property will be at risk.
Bank loans can range from a couple of thousand to many hundred thousands of pounds depending on the security and business prospects you can offer. You will be unlikely to get a loan of several hundred thousand pounds if you are opening a village corner shop. The payment periods of bank loans vary considerably depending on the amount borrowed and the individual lenders terms and conditions. The typical loan periods are between 1 and 10 years, with some going up to 20 years, though each lender is likely to have a number of different loan packages to suit various business needs.
The riskier your business, the less you are likely to able to borrow, and the higher the interest rate you will be asked to pay. This helps the bank to ensure that they are covered even if the risk does not pay off. Remember that even if you are a limited company, your loan will probably still need to be secured on your home or other assets. If you do not have enough security for the loan you need, you may be able to get extra security with the Small Firms Loan Guarantee.
Advantages of Bank Loans
Reliability – Loans are very reliable and secure, you are assured the money for the duration of the loan (unless you break terms and conditions), and the odds of a bank or major lender requiring immediate pay back is tiny. You will also be fully aware of what you owe and your repayments (unless you choose a loan with a variable interest rate). Cost – Compared to many other forms of finance, a bank loan is very reasonable in cost. Although loans are not cheap, they do not have the interest rates or charges of credit cards and overdrafts, and do not require you to give up a portion of your business as you would with investors. Equipment Life – If you are using a loan to buy equipment, you may be able to tie the loan to the usable life of the product; saving you from having to pay out in one go for expensive machinery.
Disadvantages of Bank Loans
Inflexible – Once payment terms have been set you need to stick to them, and if you borrow more than you need you could end up paying lots of extra interest needlessly. Security – If your loan is secured against your home or other assets, they will be at risk if you cannot afford to keep up repayments. Having the loan secured does provide lower interest rates, but it does mean you need to be more careful about repayments; and also be very wary of borrowing more than you can afford to repay.
Charges – Most loans will have an arrangement fee when you first get the money, while many will charge you if you repay the loan before the end of the agreed period.
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