There is a specific and very common failure mode in small business finance that almost nobody notices while it is happening. The overdraft was arranged for a good reason: a seasonal dip, a large order needing materials up front, a client who pays on 60 days. It did its job. And then, over about eighteen months, the balance stopped coming back to zero.
It is still described in conversation as the overdraft. It is functioning as a permanent loan, at overdraft pricing, secured on a personal guarantee, repayable on demand. That combination is the worst of every available option, and the reason it persists is that nothing ever forces the question.
The test that tells you which one you have
A working capital facility should touch zero, or close to it, at some point in the year. That is what it means for a facility to flex with the cash cycle: money goes out to buy stock or pay wages ahead of an invoice, the invoice gets paid, the facility clears. If your overdraft has a floor it never rises above — bankers sometimes call it the hardcore element — that portion is not working capital. It is debt that happens to sit in a current account.
The second test is structural. Add up your debtor book and your stock. If the overdraft is comfortably smaller than that total, it is genuinely funding timing, and the money to repay it exists in a form that will convert to cash. If the overdraft is larger, it is funding something else: accumulated losses, drawings taken ahead of profit, or an asset bought out of cash flow that should have been financed over its life.
That distinction determines the whole fix. Timing problems are solved with the right facility. Loss problems are not solved by any facility at all, and borrowing more only buys time to make the same loss again.
What the permanence actually costs
Illustrative figures, but recognisable. A £40,000 overdraft, average balance £35,000, interest at 11% EAR on the daily balance, plus an annual renewal fee of £600. That is roughly £3,850 of interest and £600 of fees: £4,450 a year.
Over five years that is £22,250 — and at the end of it, the £40,000 is still owed, because nothing in the structure ever repays principal. Refinance the same £40,000 onto a five-year term loan at the same 11% and the monthly payment is about £870, total repayments around £52,200, and at the end the debt is gone. You pay roughly £30,000 of interest instead of £22,250, and you buy the actual elimination of a £40,000 liability.
An overdraft charges you rent on a debt forever. A term loan charges you more per year and then stops.
The comparison also flatters the overdraft in one respect that matters. A term loan is committed for its term. An overdraft is repayable on demand — the bank can reduce or withdraw it, usually at renewal, and typically at the moment your accounts look worst, which is precisely when you can least handle it. Businesses do not usually fail because the overdraft was expensive. They fail because it was withdrawn.
Why nobody notices
Three reasons, and they compound. The balance is in the current account, so it is invisible in a way a loan statement is not — there is no monthly repayment to flinch at, just a slightly smaller number at the top of the app. Interest is charged on the daily balance and appears as a modest monthly figure rather than an annual one, so £320 a month never quite reads as £3,850 a year. And there is no maturity date, so no moment ever arrives at which someone has to make a decision.
Add to that the mild shame that keeps owners from raising it with anyone, and a facility can sit in hardcore for years. Meanwhile it is doing quiet damage to how the business is assessed: a permanently drawn overdraft is one of the clearest signals a lender reads about working capital pressure, and it shapes every subsequent conversation about credit — see what a lender sees before they read a word you wrote.
Getting out of it
Diagnose first. Pull the last twelve months of the account and find the lowest balance. That figure is your hardcore. That is the number to refinance, and knowing it changes the conversation with the bank from a plea into a proposal.
Then match the funding to the cause. If the hardcore exists because customers pay slowly, invoice finance moves the funding onto the asset actually causing it, and releases cash as invoices are raised rather than after they are paid — invoice finance still carries a stigma it does not deserve covers how it works and what it costs. If it exists because equipment was bought out of cash flow, asset finance retrospectively matches the funding to the life of the asset, and asset finance versus buying outright sets out that trade. If it exists because of accumulated losses, no facility fixes it and the work is in the trading position.
Refinance the hardcore onto a term loan and keep a smaller overdraft for genuine fluctuation. The discipline of an amortising payment is the point, not a side effect: it forces the debt down on a schedule instead of leaving it to good intentions. Compare the real cost properly rather than by headline rate — flat rate, APR or factor rate explains why lenders quote in incompatible units.
And fix the inflow at the same time, because refinancing without changing behaviour just rebuilds the hardcore over the following two years. Tighter payment terms, deposits on large jobs, and actually chasing invoices on the day they fall due do more for a working capital position than any product — the practical version is in how to chase late invoices without losing the client.
The conversation to have with the bank
Ask for it before you need it, and ask specifically. Present the twelve-month low balance, say that you want to term out that element over a defined period, and set out what is changing operationally so it does not rebuild. Banks respond considerably better to a business that has identified its own hardcore than to one that asks for a limit increase every eighteen months.
Ask what a personal guarantee actually covers while you are there, because it will almost certainly be on the table, and a guarantee given years ago on a smaller facility may already cover a much larger one — what you're really signing up for is worth reading before that meeting rather than after it.
Common questions
How do I know if my overdraft has become permanent debt?
Look at the last twelve months of the account and find the lowest balance. If the overdraft never returns to zero, the amount it never falls below — sometimes called the hardcore element — is functioning as a permanent loan rather than as working capital. A second test is structural: add up your debtor book and your stock. If the overdraft is comfortably smaller than that total, it is genuinely funding timing and the cash to repay it will arrive. If it is larger, the facility is funding accumulated losses, drawings taken ahead of profit, or an asset that should have been financed over its life.
Is an overdraft cheaper than a business loan?
Per year, often yes, because you pay interest only on the balance actually drawn. Over the life of the borrowing, usually no, because nothing in an overdraft ever repays the principal. On a £40,000 permanently drawn balance at 11% plus a £600 annual renewal fee, five years costs about £22,250 and leaves the £40,000 still owed. The same amount on a five-year term loan at 11% costs about £52,200 in total repayments and clears the debt entirely. An overdraft is also repayable on demand, so it can be withdrawn precisely when the business can least absorb it.
Can the bank withdraw my business overdraft?
Yes. Business overdrafts are ordinarily repayable on demand, which means the bank can reduce or withdraw the facility without the notice period a term loan would require, most commonly at the annual renewal. That risk is highest exactly when the accounts look weakest, which is when the business is least able to replace the funding. It is the strongest practical argument for terming out any permanently drawn element onto a committed facility with a defined repayment schedule, even where the headline interest rate on the term loan looks higher than the overdraft rate you are paying today.
What should I refinance an overdraft with?
It depends on what created it. If the balance exists because customers pay slowly, invoice finance funds the debtor book directly and releases cash when invoices are raised. If it was caused by buying equipment or vehicles out of cash flow, asset finance matches the funding to the life of the asset. If it reflects accumulated trading losses, no facility solves it and the work is in pricing, costs or volume. For a genuine hardcore balance that simply needs clearing, a term loan with an amortising repayment does the job, because the schedule forces the debt down rather than leaving it to good intentions.
