25 January 2026
Business Loan vs Overdraft: Which Is Right for You?
Two of the most popular forms of business finance in the UK are business loans and business overdrafts. They serve very different purposes, and choosing the wrong one could cost your business money. Here is everything you need to know to make the right decision.
When UK businesses need access to finance, the conversation often comes down to two options: should I take out a business loan, or would an overdraft be a better fit? Both provide access to capital, but they work in fundamentally different ways. Understanding those differences is essential to choosing the product that genuinely supports your business rather than adding unnecessary cost.
What Is a Business Loan?
A business loan is a lump sum of money borrowed from a bank, alternative lender, or financial institution, which you repay over a fixed term with interest. The repayment schedule is agreed upfront, typically in monthly instalments, and the loan term usually ranges from one to ten years depending on the amount and lender.
Business loans can be secured (backed by an asset such as property or equipment) or unsecured (no collateral required, but often with higher interest rates). Loan amounts in the UK typically range from £1,000 to £500,000 or more for established businesses, though most SME loans fall in the £5,000 to £150,000 range.
The interest rate may be fixed or variable, and you will know exactly how much you need to repay each month from the outset. This predictability is one of the biggest advantages of a business loan.
What Is a Business Overdraft?
A business overdraft is a flexible credit facility attached to your business bank account. It allows you to spend beyond your account balance, up to a pre-agreed limit. You only pay interest on the amount you actually use, and there is no fixed repayment schedule. As money comes into your account, the overdraft balance reduces automatically.
Overdraft limits for UK businesses typically range from £500 to £50,000, though larger facilities are available for bigger companies. The interest rate is usually variable and can be higher than a business loan rate, particularly for smaller overdrafts.
It is important to note that overdrafts are technically repayable on demand, meaning the bank can reduce or withdraw the facility at any time, although this rarely happens without warning.
Pros and Cons of a Business Loan
Advantages
- Fixed repayment amounts make budgeting straightforward
- Lower interest rates compared to overdrafts, especially for secured loans
- Suitable for larger amounts and longer-term investments
- Structured repayment helps enforce financial discipline
- Wide range of lenders and products available in the UK market
Disadvantages
- Less flexible than an overdraft once the funds are drawn
- You pay interest on the full amount from day one, regardless of how quickly you use the funds
- Early repayment fees may apply with some lenders
- Application process can be more involved, requiring documentation and credit checks
Pros and Cons of a Business Overdraft
Advantages
- Maximum flexibility: draw and repay as often as you like
- Only pay interest on the amount you actually use
- No fixed repayment schedule to manage
- Ideal for smoothing short-term cash flow gaps
- Quick to arrange, often available through your existing business bank
Disadvantages
- Higher interest rates than most business loans
- Limits are typically lower, usually unsuitable for large investments
- Repayable on demand, which can create uncertainty
- Fees for exceeding your agreed limit can be steep
- Easy to become reliant on the overdraft if not managed carefully
When to Choose a Business Loan
A business loan is generally the better choice when you need a specific amount of money for a defined purpose and you know how long you need to repay it. Common use cases include:
- Purchasing equipment or vehicles: A fixed asset purchase with a known cost is ideally suited to a fixed-term loan.
- Expanding premises or refurbishing: Large capital projects that will generate returns over time.
- Hiring staff: If you need to invest in recruitment and onboarding costs for a growth phase.
- Consolidating existing debts: Combining multiple smaller debts into one manageable monthly payment.
When to Choose an Overdraft
An overdraft works best as a short-term safety net for managing cash flow fluctuations. It is not designed for long-term borrowing. Ideal scenarios include:
- Bridging gaps between invoices: If your customers pay on 30, 60, or 90-day terms, an overdraft covers expenses while you wait.
- Seasonal fluctuations: Businesses with predictable quiet periods, such as hospitality or retail, can use an overdraft to manage leaner months.
- Unexpected expenses: A broken-down van, an emergency repair, or an unplanned VAT bill can all be covered quickly.
- Day-to-day cash flow management: Keeping the business running smoothly when outgoings temporarily exceed income.
Cost Comparison
The cost of borrowing varies significantly between loans and overdrafts. Here is a general comparison for the UK market:
| Factor | Business Loan | Overdraft |
|---|---|---|
| Typical APR | 3% – 20% | 8% – 25%+ |
| Arrangement fees | 0% – 3% | Often £50 – £200/year |
| Interest charged on | Full loan amount | Amount used only |
| Best for | Planned investments | Short-term cash flow |
While overdraft interest rates appear higher, the fact that you only pay interest on what you use means they can be cheaper for very short-term borrowing. However, if you find yourself permanently in your overdraft, a business loan would almost certainly be the more cost-effective option.
How to Decide
Ask yourself these questions:
- Do I need the money for a specific, one-off purpose? If yes, a loan is likely better.
- Is this a short-term cash flow issue? If yes, an overdraft may be more appropriate.
- Do I need more than £25,000? Loans are generally better for larger amounts.
- Do I want predictable repayments? A fixed-rate loan gives you certainty.
- Will I repay the amount within a few weeks? An overdraft keeps costs low for very short-term needs.
Many businesses benefit from having both: a loan for planned investments and an overdraft as a cash flow safety net. The two products complement each other well.
The Bottom Line
There is no single right answer. The best product depends entirely on your business needs, the amount you need to borrow, and how quickly you can repay it. If you are unsure, a finance broker can assess your situation and recommend the most suitable option. At Compare Business Finance, we help UK businesses compare both loans and overdrafts from multiple lenders, ensuring you get the product and terms that genuinely fit your business.