Here Are the Differences Between a Cash Credit and an Overdraft Facility

If you are a businessman or a self-employed professional and hold a current account with a financial institution, chances are you have come across the term cash credit and overdraft facility at least once. While both these terms might appear to be similar superficially, there is more to their differences than meets the eye, and in today’s article, we will discuss exactly that.

What Is a Cash Credit?

A cash credit facility is basically a short-term loan offered by financial institutions to their depositors to meet their urgent requirements. Mostly offered to current account holders, a cash credit can also be understood as a working capital loan that is extended to business owners. 

Usually arriving with a fixed rate of interest, most financial institutions have this facility in place such that businesses, especially small and medium-scale ones, can acquire access to instant funds when they require it the most.

What Is an Overdraft Facility?

Another feature extended to current account holders; this feature allows them to withdraw cash from their accounts even if the present balance in the account is below MAB (Monthly Average Balance) or even zero. 

While a cash credit is a short-term loan, meaning patrons are offered upto 12 months to repay the amount, an overdraft facility is usually very short-term in nature, meaning that you usually need to repay the amount within 5 to 7 business days or 30 business days at maximum. 

One similarity between cash credit and overdraft is that both these financial instruments are approved based on hypothecation and after analysis of the financial statements of the business.

Differences Between Cash Credit and Overdraft

While the overarching concept between a cash credit facility and overdraft are similar, there are still some significant differences between these two, and they are as mentioned below. 

• Rate of Interest

Cash credit loans in India generally arrive with an interest rate of 10.4% to 11.5% per annum; however, the exact rate of interest is generally decided by the lender after assessing a number of factors.

On the other hand, an overdraft facility generally arrives with a floating rate of interest between 8.70% per annum to 10% per annum. 

Thus, generally, an overdraft facility is much costlier as compared to a cash credit facility. 

• Eligibility Criteria

Cash credit facility in India is generally offered based on hypothecation of stock holdings, current investments and inventory with the bank. On the other hand, the overdraft facility is generally made available on the basis of credit history, relationship with the bank, investments such as FD, RD, stocks, and more. 

Along with this, the loan amount in the case of cash credit is dependent on the amount of inventory the business currently has, while on the other hand, the loan amount in an overdraft facility is dependent on a predetermined amount. 

• Avenue of Spending

Cash credit facilities are exclusively offered to be used in business requirements, meaning you cannot spend the amount for your personal expenditure. On the other hand, in some cases, an overdraft facility is even offered to savings account holders, and thus it can be spent both on personal as well as business requirements. 

Additionally, the amount of cash credit made available to a borrower does not reduce with time, but since the overdraft facility has a preapproved upper cap, with each cap, the loan amount for a repeat application gets reduced until complete repayment occurs.

• How to Avail

In most banks and financial institutions, if you want to avail a cash credit, you will typically need to open a new account. On the other hand, the overdraft facility, by definition, is offered on the existing account, and the borrower does not need to open a new account. 

Along with this, you can avail the cash credit facility for a minimum period of 1 year, while in the case of an overdraft facility, it is a maximum of one year.

Since in the case of a cash credit facility, you anyway need to open a new account, you can approach any financial institution for the same; however, in the case of an overdraft facility, you can only avail it from your present financial institution if you have a current account and an existing relationship with them. 

• Sanction Process

Last but not least, the cash credit facility is mainly extended based on market conditions and past performance of your business, whereas the overdraft facility is extended based on your current financial statements and also credit history. 

Along with this, a cash credit facility generally takes anywhere from 5 to 7 business days to be approved, whereas an overdraft facility can be approved within 48 hours if you have a standing relationship with the bank.

Key Aspects to Consider

Since both cash credit and overdraft facilities are essentially short-term loans, you should be aware of the following aspects before undertaking either of them. 

• Processing Fee

In most cases, there will be a significant processing fee attached to your application. Sometimes referred to as documentation charges, you will either need to pay this amount separately, or the bank will deduct it from the loan amount. 

• Interest Rates

Banks generally charge a fixed rate of interest for cash credit facilities but a floating rate of interest for overdraft facilities. What this means is that in the case of a cash credit facility, the rate of interest will remain the same throughout the tenure of the loan, and in the case of an overdraft facility, it will change from time to time, based on market conditions as well as the amount of repayment yet to be made.

• Foreclosure

Both overdraft facility and cash credit come with the facility of foreclosure, where the borrower can pay a small fee, usually 1% to 2% of the loan amount, and foreclose the loan.

Conclusion:

Knowing about the difference between cash credit and an overdraft is crucial when running your business as it empowers you with the knowledge of which financial instruments to utilize when you are in urgent need of cash. 

Now that you know of the difference between them, let us know in the comments below which one you will apply for first. All the best.