Overdrafts and Bank Loans

2. Overdraft Facilities

2.1 Overdrafts have two clear advantages.

• An overdraft is a simple, flexible way of financing changing cashflow requirements.
• You pay interest only on the amount you are overdrawn each day.

2.2 There are also substantial disadvantages.

• In most circumstances, the bank can demand repayment at any time.
• The overdraft has to be regularly renegotiated, depending on how long it is needed for.The bank will want to check your creditworthiness has not deteriorated.

2.3 The bank will charge you setting-up costs as well as interest.

• You are usually charged an arrangement or commitment fee whenever you set up or renew an overdraft facility.A typical fee might be 2 per cent for a £5,000 facility, falling to 0.25 per cent for facilities of £1 million or more.
• Large overdrafts may incur additional charges similar to loans (see 3.3).
• You will pay higher fees for an 'informal' overdraft (eg where you go overdrawn without agreeing it in advance with your bank) than you would for a pre-arranged, or 'formal', overdraft.

2.4 The effective interest you pay may be boosted by other charges.

• You pay a fixed margin over base rate. As base rates rise or fall, so will the interest rate charged on your overdraft.
• You can try to negotiate a narrower margin.A margin of one to five per cent over base rate is typical. In general, the larger the facility and the better your credit score (see 4.1), the lower the margin will be. There is less room for negotiation on facilities of £100,000 or less.
• Larger overdraft facilities may carry a non-utilisation fee on the amount of the facility you are not using.A typical charge is 1.5 per cent.
• You may also have to pay for regular (typically quarterly) reviews.