Understanding the Overdraft Facility: Benefits and Key Considerations

An overdraft facility is a financial tool that lets you withdraw more money than you have available in your bank account, up to a certain limit. This option is a great way to access funds for temporary cash flow or unexpected expenses without constantly applying for new loans. Let’s see what an overdraft means, its types, and ways to use it effectively.

Overdraft Facility: Meaning and How It Works 

Think of an overdraft facility as a pre-approved credit line that offers you access to funds up to a specific limit. It works by linking to your current or savings account, effectively turning it into an overdraft account. Based on your eligibility, your bank or financial institution sets a predetermined overdraft limit. You can withdraw funds from this approved credit limit as needed, up to the sanctioned limit.

There are no minimum monthly payments; you only pay interest on the exact overdraft amount you use, for only the duration you use it. Interest is typically calculated daily on the outstanding overdraft balance and debited to your account monthly. Once you repay a portion of the overdraft, interest stops accruing on that repaid portion.

How Overdraft Facility Works?

Let's understand this with the following example:

Your Total Sanctioned Limit: ₹100,000

Annual Interest Rate: 15%

Daily Interest Rate: 15% ÷ 365 = 0.0411% per day

Day 1-15: You withdraw ₹20,000

Your daily interest = ₹20,000 × 0.0411% = ₹8.22 per day, and total interest for 15 days = ₹8.22 × 15 = ₹123.30

On Day 16: You repay ₹10,000

Your outstanding balance is reduced to ₹10,000, and interest is calculated only on that amount from this point forward until your next transaction. Interest on the repaid ₹10,000 portion stops accruing immediately.

Also Read: Which is the Better Personal Loan - Term Loan or Overdraft?

Types of Overdraft Facilities in India

In India, there are mainly two types of overdraft facilities available:

Secured Overdraft Facility

For this credit facility, you need to pledge an asset as collateral and receive a higher credit limit at a relatively lower interest rate. Common forms of security include:

• Against Property: Residential or commercial property.

• Against Securities: Financial assets like shares or mutual funds.

• Against Fixed Deposit: FD as collateral, which is often a quick option.

• Against Insurance Policy: Surrender value of your life insurance policy.

Unsecured Overdraft Facility

You don’t need any collateral for this overdraft loan, and it is approved based on your income and credit history.

• If you’re a salaried individual, lenders may offer a personal loan overdraft facility based on your salary account and employment record. This is also known as a salaried overdraft.

• If you’re a self-employed professional, this is provided based on the financial health and turnover of your business. It is a great option for short-term borrowing to manage operational costs.

Also Read: Overdraft vs Cash Credit: The Ultimate Guide to Smarter Borrowing

Eligibility Criteria and Documents Required

While requirements vary between lenders, eligibility generally includes your income, age, and creditworthiness.

Eligibility Criteria

• Age: Between 21 and 65 years old.

• Credit Score: Ideally good, preferably 650 or higher.

• Documentation: Proof of identity, address, and income (standard KYC and financial documents).

Documents Required

• Proof of Identity: PAN Card, Aadhaar Card, Passport, or Voter ID.

• Proof of Address: Aadhaar Card, latest utility bills (electricity, water), or rental agreement.

• Income Statements:

  • For Salaried Individuals: Latest salary slips and bank statements.

  • For Self-Employed: Recent Income Tax Returns (ITR) and audited financials.

Benefits of Using an Overdraft Facility

An overdraft facility can give you many benefits to manage your personal and business finances:

• Immediate Access to Funds: You can withdraw more than your available balance, so you get immediate financial support. This can be useful in emergencies or for acting on time-sensitive opportunities.

• Cost-Effective Credit: Paying interest on the exact amount you use from your overdraft limit, not on the total sanctioned amount, helps you save on unnecessary costs. 

• Flexible and Penalty-Free Repayment: You can repay the utilised amount in parts or in full whenever you have surplus funds. Note that while many overdraft products don't charge prepayment or foreclosure fees, this varies by lender and specific overdraft facility.

• No Collateral for Unsecured Options: Several lenders offer unsecured overdrafts, where you don’t need to pledge any assets or security, in many cases.

• Effective Cash Flow Management: If you run a business, this option can help you fund temporary shortages so you can make your payments on time. 

• Convenience: Once approved, your overdraft acts as a revolving line of credit. You can use and repay funds as often as needed within your limit without a new application each time.

• Improves Financial Profile: Responsible usage and timely repayments can help improve your credit score and maintain a strong business reputation with suppliers and partners.

Also Read: What are Various Options to Avail of Business Loans in India?

To Conclude

An overdraft facility offers ready access to funds while ensuring you only pay for what you use, making it a valuable tool for both personal and business finance. Evaluating your own circumstances against its features will help you maintain financial stability.

If you need urgent financial solutions, an Instant Personal Loan online by Poonawalla Fincorp can help you get a loan amount of up to ₹5 Lakh. It comes with minimal documentation, quick approval and zero hidden charges.

FAQs

What is the main difference between an overdraft and a term loan? 

An overdraft is a credit line where you pay interest only on the utilised amount, while a term loan provides a lump-sum amount that is repaid in fixed EMIs.

How is interest calculated on an overdraft loan? 

Interest on an overdraft loan is calculated daily on the outstanding amount and is usually charged to your account at the end of each month.

Is it possible to get an overdraft facility without providing any security? 

Yes, an unsecured overdraft is broadly available. Lenders approve it based on your repayment capacity, credit score, and existing relationship with them.

How does overdraft repayment work? 

Overdraft repayment is flexible. You can deposit funds back into the account at any time to reduce the outstanding balance and the interest burden.