Business overdraft vs line of credit vs term loan: which suits your cash flow?
How Australian business overdrafts, lines of credit and term loans are priced, with a worked example of limit fees versus interest and a decision checklist.
A business overdraft or line of credit suits timing gaps in cash flow: you pay suppliers before customers pay you, and you clear the balance when they do. A term loan suits a one-off need with a long life, such as fit-out, equipment or buying a business. The cost works differently: with an overdraft you usually pay interest only on what you draw plus a fee on the whole limit, whereas a term loan charges interest on the full amount from day one. Picking the wrong one either wastes money on unused funds or leaves a long-term asset financed by a facility the lender can review every year.
This guide sits under the small business loan rates overview. Figures are illustrative.
How each facility works
| Feature | Business overdraft | Line of credit / revolving facility | Term loan |
|---|---|---|---|
| Where the money sits | Your transaction account goes below zero | Separate facility you draw down into your account | Paid out as a lump sum |
| Interest | On the daily drawn balance | On the drawn balance | On the outstanding balance from settlement |
| Fees | Limit or line fee on the approved limit, plus account fees | Line fee or undrawn fee, review fees | Establishment fee, sometimes a monthly fee |
| Repayment | No set schedule; balance should swing back towards zero | Interest monthly; principal as agreed | Set repayments over a term |
| Review | Usually reviewed annually; limit can be reduced | Annual or periodic review | Fixed term; reviews tied to covenants |
| Security | Often property or GSA for larger limits | Often property-secured | Depends on the loan |
A "hardcore" overdraft that never comes back to zero is a warning sign. Lenders notice when the limit is fully used for months; it suggests the business needs longer-term funding or has a trading problem.
Worked example: limit fee plus interest
A wholesaler has a $50,000 overdraft limit (illustrative pricing):
- Line fee: 1.5% a year on the limit = $750
- Interest: 11% a year on the drawn balance
- Average drawn balance across the year: $20,000, so interest is about 11% × $20,000 = $2,200
Total annual cost: $750 + $2,200 = $2,950. Measured against the average $20,000 actually used, that is an effective cost of about 14.75% a year ($2,950 ÷ $20,000).
Compare a $50,000 term loan at 9.5% drawn in full on day one. In the first year the interest is about $4,400 (the balance falls slightly as you repay), even though the business only needed an average of $20,000. The overdraft is cheaper here despite the higher rate, because you are not paying for idle money.
The result flips if the average drawn balance is close to the limit. At an average $45,000 drawn, the overdraft costs $750 + $4,950 = $5,700, an effective 12.7% on the money used, which is dearer than the term loan. You can test term-loan figures in the repayment calculator.
Seasonal businesses
Farmers, tourism operators, retailers before Christmas and builders waiting for progress payments often have predictable peaks. Options:
- A seasonal limit that rises for agreed months and falls afterwards.
- A line of credit with an annual clean-up period when the balance must be cleared.
- Invoice finance if the gap is caused by customers on long payment terms. See factoring vs discounting.
- Trade finance for import cycles.
Agricultural borrowers can also look at government and state programs covered in government-backed finance.
What lenders check before granting a limit
- Bank statements showing how the account swings and whether you bounce payments.
- Aged debtors and creditors: are customers paying on time?
- BAS and financial statements to confirm turnover and margins.
- Your tax position: unpaid GST or PAYG withholding is a serious concern because it can lead to director penalty notices.
- Security: larger limits commonly require property or a GSA.
The full list is in the application checklist.
Review risk
Overdrafts and lines of credit are commonly "on demand" or subject to periodic review. A lender can decide to reduce or not renew a limit, which can be harder to absorb than a term loan with a fixed schedule. Read the review and termination clauses. For subscribing banks, the Banking Code of Practice includes commitments about notice and how decisions are communicated to small business customers; check the current Code wording. The covenants and reviews guide covers what to do if a limit is cut.
Decision checklist
- Is the need short-term and repeating (overdraft/line) or one-off and long-lived (term loan)?
- What would your average drawn balance be? Multiply by the rate and add the limit fee.
- Can the business survive if the limit were reduced at the next review?
- Is the overdraft being used to pay tax or wages every month? That signals a deeper cash flow problem.
- Does the facility need property security, and are you comfortable with that?
Mistakes to avoid
- Financing a vehicle or fit-out through the overdraft, then finding the limit permanently used.
- Keeping a large unused limit "just in case" and paying the line fee for years.
- Ignoring the annual review date and missing information requests.
- Paying ATO debts from the overdraft without a plan, which only moves the problem.
Frequently asked questions
Can I have an overdraft and a term loan with the same lender?
Yes, and lenders often package them, usually under a single security arrangement. That can be efficient, but a default on one facility can affect the others through cross-default clauses.
Is the line fee charged if I never use the overdraft?
Usually yes. It pays for the lender's commitment to lend. Ask whether it is charged on the limit or only on the undrawn portion.
How quickly can a bank cancel an overdraft?
It depends on the contract and any code the lender has signed. Many facilities allow review or cancellation with notice. Read the termination clause and ask for the notice period in writing.
Does a business credit card replace an overdraft?
For small purchases it can, with an interest-free period if cleared each month. Card rates are usually higher than overdraft rates if a balance is carried.
Sources
- Reserve Bank of Australia — cash rate and business lending statistics
- business.gov.au — managing cash flow and business finance options
- Australian Banking Association — Banking Code of Practice — small business lending commitments
- ATO — payment plans and director penalty regime
