The rate on an overdraft is usually higher than a term loan and the cost is usually lower. Both statements are true at once, and the arithmetic that reconciles them decides which product you should be asking for.
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An overdraft is usually quoted two or three points above a term loan, and usually works out cheaper. That is not a contradiction, and the arithmetic behind it is the most useful thing on this page.
A business needs about ₹10 lakh, but only for roughly ten days a month — the gap between paying suppliers and customers settling.
| Term loan at 14% | Overdraft at 17% | |
|---|---|---|
| Amount | ₹10 lakh | ₹10 lakh limit |
| Days outstanding per month | 30 | About 10 |
| Interest-bearing days per year | 365 | About 120 |
| Rough annual interest | About ₹1.4 lakh | About ₹56,000 |
The overdraft carries a rate three points higher and costs roughly 60% less, because the rate is applied to a balance that exists for a third of the year. Figures here are illustrative and rounded; the principle is what matters.
This is why "which has the lower rate" is the wrong question. The right one is: how many days a year will the money actually be outstanding? Under about half, a revolving limit usually wins. Continuously, a term loan usually does.
You are sanctioned a limit — say ₹20 lakh — on your current account. Balances below zero, down to that limit, are permitted. Interest accrues daily on the drawn amount and is debited monthly. There is no EMI, no repayment schedule and no prepayment penalty; money credited to the account automatically reduces the drawn balance and the interest with it.
That last point is worth using deliberately. Parking receipts in the overdraft account rather than in a separate savings account reduces interest every single day they sit there — a small habit that adds up over a year.
An overdraft is designed to fluctuate. Drawn, repaid, drawn again. When the balance never returns to zero across an entire year, something has gone wrong — and both you and the lender should read it the same way.
It usually means one of two things. Either the limit has been used to buy an asset, in which case it is a term loan wearing the wrong label and you are paying revolving pricing on a long-term borrowing. Or the business is running a structural deficit that the limit is quietly funding, which is the more serious diagnosis.
Lenders watch for exactly this at annual review. A permanently drawn limit commonly triggers a reduction, a demand for conversion to a term loan, or additional security. Better to notice it yourself and restructure on your own terms.
The limit is not guaranteed for life
An overdraft is renewable, not permanent. It is reviewed every twelve months, and it can be reduced or withdrawn — usually with notice, but not always at a convenient moment. A business that treats its overdraft as permanent capital is exposed to a decision it does not control. Keep the limit as a buffer for genuine cycles, not as the foundation of the balance sheet.
Broadly the same criteria as any business facility — vintage, turnover, declared income, credit reports — with extra weight on current account conduct, since the account is the product. Twelve months of clean operation, no cheque returns and healthy average balances matter more here than on a term loan.
Security varies. A clean overdraft is available to strong files. Cash credit against stock and book debts is common for traders and manufacturers. Property-backed overdrafts carry the largest limits and the finest pricing. CGTMSE cover can substitute for collateral for Udyam-registered enterprises.
Q1. How is overdraft interest calculated?
On the daily closing drawn balance, accrued daily and debited monthly. Draw ₹3 lakh of a ₹20 lakh limit for six days and you pay interest on ₹3 lakh for six days — nothing on the undrawn ₹17 lakh, and nothing for the remaining days.
Q2. Is an overdraft better than a business loan?
For recurring, uneven needs, usually yes, because you pay only for the days you use it. For a one-off purchase repaid over years, a term loan is better — the overdraft would stay drawn permanently and cost more while consuming the buffer you may need later.
Q3. What is the difference between an overdraft and cash credit?
Cash credit is specifically drawn against current assets, with the limit reset periodically from stock statements. An overdraft sits on the current account and may be secured against assets or extended clean. Operationally they behave the same.
Q4. Can I get an overdraft without security?
Yes, for a strong file — good vintage, healthy banking and clean credit reports. Limits are smaller than secured facilities and rates higher. CGTMSE cover is worth asking about if you are Udyam-registered.
Q5. What if my limit is fully used all year?
Treat it as a signal rather than a status quo. It means the borrowing is structural rather than cyclical, and it is likely to be flagged at renewal. Converting the permanently used portion into a term loan and keeping a smaller revolving limit for genuine cycles is usually cheaper and safer than waiting for the bank to raise it.
Money Bharti works out which structure costs less in rupees for your actual usage pattern, across RBI-registered banks and NBFCs. Soft enquiry only — nothing lands on your credit reports.
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