Overdrafts and Bank Loans

3. Loans

3.1 The biggest advantage of a loan is the fact that you can bank on having the money.

• Once you have arranged a loan, the financing is secure for the life of the loan (unless you fail to make payments or breach any covenants - see 3.2).
• You can match the term of a loan to the life of an asset you want to purchase. For example, you can finance the purchase of a machine which will have a working life of five years using a five-year (or shorter) loan. By the time the machine is obsolete, the loan will have been paid off.
• You may be able to tailor the loan to match the cashflow of the project you are using the loan to finance.
• You can usually fix the loan interest rate.
• You may be able to get a special loan.

3.2 The disadvantages of a loan may include a lack of flexibility.

• You pay interest on the full amount of the outstanding loan.
• The bank often imposes legally binding covenants before agreeing to a loan. For example, the bank may insist you keep your overall gearing below a certain level.If you breach these conditions, the bank will be entitled to immediate repayment.
• You do not have access to the portion of a loan which you have repaid, unless you apply for a new loan.
• The bank will usually require a fixed charge or some other form of security (see 5).

3.3 The setting-up costs for a loan may be just as high as for an overdraft.

• You are usually charged an initial arrangement or commitment fee. A typical fee might be 1.75 per cent for a £30,000 loan, falling to 0.25 per cent for a loan of £1 million or more.
• You might be required to take out insurance, such as key man cover.
• You may be charged for the bank's other costs. For example, for an assessment of the value of the security you are offering or to manage exceptionally complicated loans.

3.4 As well as interest, you will have to pay other charges.

• You usually pay a fixed margin over base rate for floating rate loans of less than £100,000. A margin of one to three per cent is typical, depending on your credit score (see 4.1).
• For larger amounts, you can choose to negotiate a fixed rate loan. This makes it easier to budget for interest payments.
• If you want to repay a loan early, you may be charged a pre-payment fee.A typical charge is one per cent plus a charge to compensate the bank for its interest costs.