What is Overdraft Facility in Bank Accounts?
An overdraft facility provided by the bank allows you to withdraw more money than what is available in your account up to a particular approved limit. It is like a short-term credit agreement between you and your bank.
Features of Overdraft Facility
- An overdraft facility in bank accounts is like a pre-approved loan. The bank ascertains a specific limit up to which you can overdraw on your account balance. You can withdraw that amount as and when required.
- The approved limit and the overdraft facility interest rate are determined depending on your typical account balance, financial stability, nature of the collateral, etc.
- The bank charges interest only on the amount used by you and only for the time it is borrowed. It is calculated daily and billed to you every month.
- While the overdraft facility interest rate is predetermined, it may increase if you default on paying back the amount due.
- You can pay back the amount as and when you have the funds, as a lump sum or in part payment, and there is no prepayment penalty or EMI concept like in loans.
- While there is no minimum monthly repayment, you should pay it back when you have the money because it does affect your credit score.
Types of Overdraft Accounts
Similar to loans, there are secured and unsecured overdraft facilities. It means that if you opt for a secured overdraft account, you will have to provide collateral for the same. There are a few different collaterals you can provide.
They are as follows:
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Overdraft against Salary
Overdraft facility for salaried individuals is available against your monthly income. Depending on the bank, you may be approved for a limit of about two times your salary. However, to avail of this facility, you need to have a salary account with the same bank.
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Overdraft against House or Property
You can pledge your property to start an overdraft account with your bank. Even if you currently have a home loan that you’re paying back, you’ll still be eligible after a thorough check by the bank.
Typically, banks allow for the overdraft limit to be around 50% of the property’s value.
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Overdraft against Fixed Deposits
Fixed deposits work as a better collateral alternative than housing property if you don’t need a high limit. The process is quicker, and the documentation is minimal.
Another plus to this option is that if you have a fixed deposit with the same bank, you’re applying for an overdraft account to, the process will be further expedited. The interest rate is also lower, and the limit sanctioned can be as high as 75% of your fixed deposit.
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Overdraft against Insurance Policies
Another great collateral option for an overdraft facility is any insurance policies that you hold. The important factor here is the surrender value of your policy – it is the amount the insurance company will pay you if you decide to terminate the policy before maturity.
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Overdraft against Equity Investments
It should be a last resort, as equity investments are the least preferred collateral for an overdraft account. Since equities are subject to market fluctuations, the limit sanctioned for the overdraft facility will be on the lower end.
Bank Accounts Eligible for Overdraft Facility
Initially, current accounts meant for business transactions were offered the overdraft account facility. However, now most bank account holders can avail of this facility irrespective of the type of bank account they hold. Overdraft facility is available to:
- Current account holders
- Salary account holders
- Savings account holders
- Deposit account holders
Process Of Applying for an Overdraft Facility in Bank Accounts
Like with loans and credit cards, some bank account holders are already pre-approved for an overdraft facility. If you are one of them, it means that if you withdraw more money than what is available in your bank account, your balance will go negative, and the overdraft facility will be automatically activated.
As for those who are not pre-approved, you can reach out to your bank. Most banks now have a quick application process online with instant sanctions. There are different application forms depending on what you are offering as collateral – salary, fixed deposit, etc.
Difference Between Overdraft Account And Personal Loan
A personal loan is a loan, but an overdraft account is a line of credit. Hence, the most essential difference is the terms of repayment. An overdraft doesn’t involve EMIs or have foreclosure charges like a personal loan and is more flexible.
The interest in a personal loan is charged on the entire loan amount, but only the amount actually overdrawn is charged in an overdraft account. Moreover, the interest is calculated every month on a personal loan but daily in overdrafts. The overdraft facility interest rate is fixed, whereas it can be fixed or floating in personal loans.
Key Takeaways
While overdraft accounts can be a blessing, they can also become a menace if one does not handle them responsibly.
An easily available line of credit always sounds exciting, but to prevent yourself from any exigencies in the future, you should also spend it prudently.