All About Overdraft


What is an overdraft?

An overdraft (OD) is a credit facility that allows you to transact or withdraw funds even if your account balance is zero. It is basically an extension of credit that the lender provides in the event of an emergency when your account has inadequate funds.

KEY TAKEAWAYS

  • You can use the overdraft facility when your account limit is low, but you need to withdraw a larger amount.
  • Many financial institutions levy overdraft fees on overdrawn accounts.
  • Overdraft works the same as any other loan, and you must pay interest on the OD facility in accordance with the loan agreement.

Advantages of overdraft facility

There are multiple benefits associated with an overdraft facility, and a few are as follows.

  • Quick access:
    Unlike other loans, overdrafts do not require you to go through a lengthy application process to obtain funds. If your bank offers this service and you choose to use it, you will have immediate access to funds when the need arises.
  • Offers control:
    When you apply for an overdraft facility, the maximum amount you can overdraw during the crisis is pre-decided. Since you are well aware of your borrowing limit, you can exercise complete control over your expenses by eliminating unnecessary ones.
  • Pay as you use:
    The lender does not impose interest on the predetermined limit that you may overdraw. Instead, the interest rate is charged only on the amount overdrawn.
  • No foreclosure charges:
    The lender will not charge you a penalty if you pay off the entire overdraft before the binding due date.

Disadvantages of overdraft facility

Before proceeding with the overdraft facility, it is vital to weigh its drawbacks.

  • Limited options:
    Unlike other loans that provide you with an option to apply with the lender of your choice, overdraft does not provide this benefit. You can only apply for this loan with a banking institution where you have an active account.
  • Budgeting is difficult:
    The overdraft interest rate is variable. Moreover, tracking the same is difficult even with the availability of a loan EMI calculator. The situation can sometimes result in ineffective budget management, and if the amount in question is large enough, default is likely.
  • Hefty fees:
    If you exceed your overdraft facility limit without any prior authorisation, the lender may levy a hefty penalty.

Types of OD

There are two kinds of overdrafts. The first is secured, whereas the second is unsecured. These are further subdivided into different types, which we will discuss in the pointers. If you choose secured overdraft, you can back it up with any asset. In the event of loan non-payment, the lender has the right to auction off your asset to recoup their losses.

On the other hand, unsecured overdrafts offer a lower credit limit due to the higher credit risk. Other common overdrafts facilities are:

  • OD against salary:
    If you have a salary account with any bank, you may be eligible for an overdraft limit of two to three times your salary based on your transactions and monthly account maintenance balance.
  • OD against the house:
    This type of overdraft facility is ideal if your requirements are higher and you own a home. The lender allows you to overdraw for an amount ranging from 40 to 50% of the house’s current market value.
  • OD against fixed deposit:
    When you invest in a fixed deposit with any bank, you can avail yourself of an overdraft against it. The lender charges interest on such credit at a rate usually 1-2% higher than your FD return on investment.
  • OD against insurance:
    The overdraft limit on this type of loan is determined by the surrender value of your life insurance policy.

Features of OD account

To comprehend the concept, it is critical to learn about the characteristics of overdraft.

  • Overdrafts are available on both savings and current accounts.
  • The interest is charged only on the amount overdrawn, not the approved limit.
  • Credit is extended based on your existing account transactions, balance maintenance, current and past loan repayment record, and credit score.
  • An overdraft is a short-term credit facility with a repayment term of a year or less.

Does OD affect credit score?

Overdrafts do not harm your credit score if you pay off your outstanding balance with interest on time. Looking at it from a different perspective, it helps you maintain your credit score by avoiding situations, such as a cheque bounce.

Assume you have a Personal Loan with an EMI of around ₹10,000, and your account balance is ₹2,000 on the day you pay your EMI. If you have an overdraft facility, your cheque will be cleared in this case. However, if you do not have this option, your EMI will be delayed, and your credit score will suffer.

How to get OD instantly?

Obtaining an instant overdraft facility is similar to applying for any other loan form. In some cases, banking institutions will pre-approve you for this loan product based on the type of account you have. As soon as the withdrawal amount exceeds the available balance, the overdraft loan is activated immediately.

However, if the bank does not provide this service with your account, you must submit a request letter along with documents proving your credibility. Before deciding on your approval or overdraft limit, the bank will review your credit report, income, and other factors. If your credit score is low, you can mortgage your valuable assets or pledge your investment for immediate approval.

Final words

An overdraft is a credit facility that allows you to conduct transactions through your bank account even if your account balance is zero. This type of loan is helpful during a financial emergency, especially when one needs the money in no time. However, keep in mind that OD has additional fees and an interest rate. As a result, before proceeding with this financing option, it is critical to consider the cost of borrowing.

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