The short version
- An overdraft or line of credit is a limit. You draw what you need, pay it back, and draw again. You pay interest only on what you've drawn.
- A term loan is a lump sum. You get it all up front and pay it back in set repayments, usually over 2 to 5 years.
- Use a limit for gaps that close within a few months. Use a term loan for anything that takes years to pay for itself.
- Rates from the non-bank lenders we use are close. Lines of credit start from about 14% p.a. and term loans from about 13.5% p.a.
- The bigger difference is how you use it. A line drawn for a few weeks is cheap. A line that sits fully drawn for years costs more than a term loan and never gets paid off.
How an overdraft or line of credit works
An overdraft is a limit on your business transaction account. Your balance can go below zero, down to the limit. A line of credit is the same idea in a separate account.
You only pay interest on the part you've drawn. Draw $40K for two months at 16.95% p.a. and the interest is about $1,130. Pay it back and the interest stops. The full limit is there again next time.
Lines of credit from the lenders we use:
- Rates start from about 14% to 15.5% p.a. for an established business with property and good credit. Most businesses land between about 17% and 25% p.a.
- Limits run from about $10K to $1M. If no director owns property, several lenders cap the limit at $100K.
- Fees vary a lot. One lender charges a 1.5% p.a. line fee on the whole limit, whether you use it or not. Others charge a yearly fee of $495 to $795, a set-up fee, or nothing at all.
- Many want more trading history than a term loan. Several ask for 2 to 3 years of trading for a line, compared with 12 months for a term loan.
- Many now make you pay it down. One lender wants at least 3% of the balance each month. Another pays each draw off over up to 5 years, like a small loan. Some short-term lines charge a fee each time you draw and want each draw repaid within a few months.
- Most run for a set period, often 3 to 5 years, and then get reviewed or renewed. The lender can change the limit at that point.
Bank overdrafts are usually cheaper. Banks mostly want property as security and full financials before they'll set one up. Our lines of credit page covers how lenders set the limit.
How a term loan works
A term loan gives you one amount up front. You pay it back in equal repayments until it's gone.
Borrow $100K over 3 years at 16.95% p.a. and the repayment is about $3,563 a month. You pay about $28,260 in interest over the 3 years, and then you owe nothing.
Term loans from the lenders we use:
- Rates start from about 13.5% to 13.95% p.a. for a strong business that owns property. Most businesses land between about 15% and 25% p.a. Weaker credit or a very young business can pay up to 44.5% p.a.
- Loans run from about $10K to $1M, over 2 to 5 years.
- The rate is usually fixed, so the repayment doesn't change. Many non-bank lenders take repayments weekly.
- Expect an establishment fee of up to 2.5% of the loan, or a documentation fee of around $495.
- Paying early can cost you. One lender charges 1% of what you pay back early. Others give a discount for paying early. Check before you sign.
- Once you've spent the money, you can't redraw it. To borrow more, you apply again.
Bank term loans start lower, from around 7% p.a. with property security. Our business loan interest rates guide keeps the current numbers. See our business loans page for how we arrange them.
Overdraft vs term loan at a glance
| Overdraft / line of credit | Term loan | |
|---|---|---|
| How you get the money | A limit you draw on as needed | One lump sum up front |
| Interest | Only on what you've drawn | On the full balance owing |
| Repayments | Interest only, or a minimum amount, depending on the lender | Fixed weekly or monthly repayments |
| Can you reuse it? | Yes, pay it down and draw again | No, you apply again |
| How long it lasts | Usually 3 to 5 years, then reviewed or renewed | A set term, usually 2 to 5 years |
| Rates from non-bank lenders we use | From about 14% p.a. | From about 13.5% p.a. |
| Fees | Line fee or yearly fee, set-up fee, sometimes a fee per draw | Establishment or documentation fee, sometimes an early payout fee |
| Best for | Short gaps that close in weeks or months | One-off costs that pay back over years |
Five questions to ask yourself
We talk this through with business owners every week. These are the questions we ask.
1. When will the money come back?
If you'll have the cash back within a few months, use a limit. Think wages before a progress payment lands, stock before a busy season, or a supplier bill before customers pay.
If it takes years to earn the money back, use a term loan. Think a fit-out, a new site, buying out a partner or buying another business.
2. Is it one amount or does it keep coming?
A one-off cost with a clear number suits a term loan. You borrow that number and pay it off.
A need that comes and goes suits a limit. If the gap comes from customers paying slowly, invoice finance is another option. See our guide to working capital finance.
3. Can you make a fixed repayment in your worst month?
A term loan wants the same repayment in a slow month as in a busy one. Many non-bank loans take it weekly. Check your quietest months before you commit.
A limit gives you more room. You still pay interest, and often a minimum amount, but you choose when to clear the rest.
4. Will you actually pay the limit down?
A limit only works if you clear it when the cash comes in. If you know the balance will just sit there, take a term loan. The repayments pay the debt off whether you think about it or not.
5. What will each one cost over the time you need it?
Compare the total cost, not just the rate. At the same 16.95% p.a.:
- $40K drawn on a line for two months costs about $1,130 in interest.
- The same line drawn to $100K for a full year costs about $16,950 in interest, and you still owe the $100K.
- A $100K term loan over 3 years costs about $28,260 in interest in total, and it's fully paid off.
Add the fees on top. A 1.5% line fee on a $100K limit is $1,500 a year. A 2.5% establishment fee on a $100K loan is $2,500 up front. Read the true cost of a business loan before you compare offers.
The overdraft that never comes down
This is the problem we see most often. It starts with a short-term gap. Then the overdraft gets used for a ute, a fit-out or a tax bill. A year later it's sitting at the limit and the business is only paying the interest.
The debt doesn't go down, and you've lost the buffer for your next slow month. Lenders notice too. A limit that's always maxed out shows up in your bank statements and tells a lender the business is short of cash. See how lenders read your bank statements.
The usual fix is to move the stuck part into a term loan and keep a smaller limit for real gaps. The term loan pays itself off, and the limit is free again.
What usually fits
| What the money is for | What usually fits |
|---|---|
| Waiting 30 to 60 days for customers to pay | Overdraft or line of credit, or invoice finance |
| Buying stock before a busy season | Line of credit, or a short-term loan |
| A tax bill you want to pay over 12 to 24 months | Term loan. See business loans when you owe the ATO |
| Fit-out, new site or buying a business | Term loan |
| A vehicle or piece of equipment | Asset finance, a loan secured on the asset itself |
| An overdraft stuck at its limit | Term loan for the stuck part, smaller limit for the rest |
Using both
Many businesses we work with have both. A term loan covers the big, long-term costs. A small limit covers the day-to-day bumps.
Some lenders we use will let you hold a line and a term loan together. A couple size the line off your monthly revenue when you take both.
Talk it through with us
Tell us what the money is for and when you expect it back. We'll show you what a line and a term loan would each cost across the 130+ lenders we work with. Start with the application form.
We're a broker, not a lender. All finance is subject to lender approval. This page is general information, not personal financial or credit advice. Finance for a business purpose generally sits outside the consumer credit rules in the NCCP.
Credit Representative 560751 of Viking Money Pty Ltd, Australian Credit Licence 471435 (Viking Aggregation Pty Ltd).
Sources
- Business loan, line of credit and overdraft rates from lenders Aurelius Capital works with (lenders not named)
- Interest rates, table F7 (Reserve Bank of Australia)