How big is the difference between short-term loans and overdraft facilities ? And when should you choose one solution over another? The answer is not always obvious or straightforward, which is why it requires consideration of a cash credit or a short term loan will be the best in your situation.
What is a Cash Credit?
A cash credit can be defined as a loan you take out in a bank. It is a security you acquire so that you do not have to pay tower-high interest if the account from time to time goes negative. However, it is also a security that you still pay a little to have in the form of an annual interest rate.
The overdraft facility has an agreed maximum amount of, for example, USD 10,000. If the maximum amount is exceeded, you must pay an overdraft rate that is higher than the interest rate on the cash credit. This is therefore seen as a kind of “penalty interest”. Thus, the interest on a cash credit is only advantageous if you stay within its limits.
If you have, or should you have, a cash credit, it is therefore a good idea that you, in cooperation with the bank, get the exact amount of cash credit you need. This is how you best ensure that you do not exceed the maximum amount you have agreed with the bank.
When is a Short-Term Loan Better than a Cash Loan?
Some are skeptical of short-term loans and thus whether such a loan can be a better solution than overdraft. Typically, they are of the opinion that debt should only be deposited with the bank.
Nevertheless, there are situations where it is more advantageous to take out short-term loans than have a cash loan. Paying an annual interest rate on having a cash credit is not a free benefit. If you do not use your overdraft facility, this is unnecessary money you pay annually in interest.
If you are the type where the account only hits minus one or two months a year, then a cash credit can rarely pay off. It can be a short term loan in return. A short-term loan can help you get the expense out of the world, after which you can find the right financing solution. As with the unforeseen expense, the interest cost on the loan is a lump sum you have to pay. Thus, you do not pay for anything other than what you need here and now, and you do not end up in a situation where you continuously pay for something you do not use.
However, if your account goes for less than several months a year, a short-term loan is rarely the right solution, as it indicates more general over-consumption than a single event. The situation also means that it can be just as good for you to have a cash credit as you suddenly get “value” for the annual interest rate you pay.
The difference between short-term loans and overdraft facilities is that one solution is the best alternative to a short-term need, while the other is a better alternative to a long-term need.