Overdraft vs Cash Credit: Know the Differences

Cash credit and overdraft are loans to be used for the quick supply of cash. They are intended for short periods and are called short-term cash loans. The main difference between cash credit and overdraft is that overdraft is given on an existing bank account with the bank, while cash credit is a completely separate facility and applies to individuals. Learn about cash credit vs overdraft in this blog in detail. 

What is Overdraft?

The term overdraft is when a person withdraws more money than they have in their bank account, which leads to the balance going below zero. That is, the bank balance is negative. In simpler terms, it means spending more money than you have. 

When an overdraft occurs, banks typically charge a fee for allowing the account to go into overdraft, and they may also apply interest charges on the amount that's been borrowed through the overdraft.

What is Business Credit?

Business credit is a financial arrangement primarily offered to businesses rather than individual consumers. Financial institutions, such as banks and credit unions, typically require businesses to provide collateral, tangible assets like shares or property, in exchange for access to cash. The credit limit on a business credit account is determined as a percentage of the value of the collateralised assets, providing businesses with a source of financing for their operations.

Overdraft vs Cash Credit: Tabular Comparison

The main difference between cash credit and overdrafts is that cash credit is like a secured loan for businesses with stable needs, while overdrafts are like a safety net for occasional short-term expenses of individuals. 

Let us explore these aspects in more detail - 

Cash Credit vs Overdrafts

Application

• Cash Credit - A separate application and approval process are required, often with stricter eligibility criteria than overdrafts.
• Overdrafts - They act as a safety net, providing short-term access to funds for unexpected expenses or minor cash flow gaps.

Availability

• Cash Credit - Requires a separate application and approval process, making it accessible to businesses with a strong financial profile and collateral, unlike readily available overdrafts.
• Overdraft - Often readily available on existing checking accounts without applying for a separate line of credit.

Interest Rates

• Cash Credit - Usually lower interest rates than overdrafts because cash credit is usually a secured loan, meaning it's backed by collateral like assets or inventory.
• Overdraft - Generally higher because overdrafts are typically unsecured, meaning they're not backed by any specific collateral. The lack of security increases the lender's risk, so they charge a higher interest rate to compensate.

Term

• Cash Credit - Typically long-term (e.g., 1 year or more) compared to overdrafts.
• Overdraft - Short-term, often with daily or monthly interest calculations.

Fees

• Cash Credit - May have annual or prepayment fees.
• Overdraft - Often have overdraft fees and potential non-sufficient funds (NSF) fees.

Suitability

• Cash Credit - Ideal for businesses with predictable cash flow needs and access to collateral.
• Overdraft - Best for unexpected short-term cash needs or managing minor cash flow fluctuations.

Repayment Terms

• Cash Credit - Typically involves scheduled repayments over an extended period.
• Overdraft - Repayments are generally expected when the overdraft is cleared; it's more of a short-term solution.

Credit Limit

• Cash Credit - Offers a predefined credit limit based on collateral and financial strength.
• Overdraft - Usually provides a smaller credit limit than cash credit, tied to the account balance or a set limit.

Purpose

• Cash Credit - Suited for planned investments, large expenses, or long-term financing needs.
• Overdraft - Intended for immediate, unplanned expenses or managing minor shortfalls.

Documentation

• Cash Credit - Requires extensive documentation, financial statements, and a comprehensive application process.
• Overdraft - Often involves minimal paperwork and is quickly accessible to eligible account holders.

Flexibility

• Cash Credit - Offers flexibility in using funds for various business needs.
• Overdraft - Primarily designed as a safety net for emergency or unexpected situations.

Review Process

• Cash Credit - Subject to periodic reviews, potentially leading to credit limits and terms adjustments.
• Overdraft - Generally doesn't undergo frequent reviews once established.

Secured vs. Unsecured

• Cash Credit - Typically secured by collateral or assets.
• Overdraft - Unsecured, relying on the borrower's creditworthiness.

Cost Control

• Cash Credit - Easier to control costs due to structured repayment schedules.
• Overdraft - Costs can accumulate quickly if not managed well, given the variable nature of interest.

Key Takeaways

• Cash credit and overdraft are credit facilities a lender, typically a bank, provides.
• Overdraft accounts, while allowing users to carry negative balances, may vary in terms of fees and features. 
• Some overdraft accounts may charge large fees for overdrawing, while others may have lower or no fees, depending on the type of account and the bank's policies.
• Cash credit is more commonly associated with businesses and often requires collateral or some form of security.

Conclusion

Both cash credit and overdraft act as lifelines, letting you access additional funds beyond your account balance when needed. While overdrafts allow for small temporary dips without major penalties, they're not limited to individuals; businesses rely on them, too. However, they differ in purpose and security. 

Be cautious when taking a short-term loan. You must compare different banks' interest rates and choose the one that suits your needs and budget. Make a point to read and understand the bank's terms and conditions. Also, enquire about the processing charges to understand the total cost of the loan better and make an informed decision.