Commercial Mortgage vs Overdraft Facility
With so many different types of commercial finance available from banks and other specialist lenders we thought that it would be a good idea to explore the differences between two of the most popular ones. These are the commercial mortgage and the overdraft facility.
A commercial mortgage is agreed to assist with a specific capital outlay such as to buy a commercial premises, purchase plant and machinery or consolidate an overdraft facility.
The borrowing tends to be repaid on a monthly basis over a longer term than an overdraft facility with the amount borrowed being repaid over a number of years. The repayments are calculated based upon the amount of the commercial mortgage, term and interest rate. Obviously, the repayments should be affordable as evidenced by a cash flow forecast that is often required by the lender. There are a variety of lenders providing such finance such as banks and more specialist lenders. Security will be required.
The interest rate tends to be either linked to the Bank of England’s Base Rate or LIBOR. It could be a variable or fixed rate. The rate is calculated based upon the likes of the risk that the lender feels your business presents to them. Arrangement fees are payable.
It is worth remembering that the longer the repayment term the more you will end up paying back in interest but it is important that the monthly repayments are affordable at all times. Some lenders provide an option to make lump sum reductions to the debt without paying a penalty but with some others there may be a penalty.
An overdraft facility is agreed on your business current account and is provided by your bank to provide a working capital requirement to assist with the day to day funding that a business requires to help it operate. For example, many businesses especially newly formed ones don’t have enough of their own surplus funds available to meet all the monthly expenditure so will apply to their bank for an overdraft facility. The monies could be used for a variety of purposes such as to purchase additional stock or perhaps pay for an additional marketing campaign with a view to boost sales at Christmas.
Amongst a number of things, the lender will probably require the completion of a cash flow forecast to show the maximum borrowing requirement on a month-by-month basis over the next 12 months. Ideally, you would expect to see the balance in your business current account fluctuating into credit at different periods but never exceeding the agreed overdraft facility. Security is usually required.
The interest rate that is often linked to the Bank of England Base Rate is calculated taking into account a number of factors such as the risk that the lender feels your business presents to them. Arrangement fees are payable. The facility could be agreed for various periods of time whether it is 1, 3, 6 or 12 months.
Of course, in time, it is to be hoped that a profitable business will have a reducing reliance on an overdraft facility ultimately not requiring one as the business becomes cash rich enabling it to fund its day to day operations from its own monies.
So, as you can see, a commercial mortgage is usually taken out to cover a specific capital outlay and is repayable over a number of years whereas an overdraft facility tends to be agreed to provide funding towards assisting with the day to day business operation over a shorter period of time.