What is an Overdraft Facility?
An overdraft facility enables you to withdraw cash more than your balance in an account. An easy definition is that the bank allows you to go into 'negative' on a pre-approved limit. This prevents you from running into cash shortages at inconvenient moments. The simplest example of a loan is borrowing a lump sum. In this case, there's no fixed amount—you pay a fee based on how much you use and for how long.How Does an Overdraft Facility Work?
Let’s say you have Rs. 10,000 in your account, but you need Rs. 15,000 urgently. If your bank has sanctioned an overdraft facility of Rs. 20,000, you can withdraw the extra Rs. 5,000 without any immediate issues. The bank will allow this transaction, and you will be required to repay it later, along with applicable interest.The best part? You don’t have to pay EMIs like a loan. You can repay whenever you have sufficient funds, as long as it’s within the agreed terms.
Types of Overdraft Facilities?
Here are the different types of overdraft facilities:1. Secured Overdraft – This requires collateral, such as fixed deposits, property, or other financial assets. The sanctioned overdraft limit depends on the value of the collateral.
2. Unsecured overdraft- Some credit cards are issued with a lower limit and a high interest rate due to their dependence on credit score, income, and account history.
3. Overdraft Against Salary – Some banks offer salaried persons a paycheck-linked overdraft, which provides transient financial relief.
4. Business Overdraft – Entrepreneurs and businessmen are allowed to take an overdraft and meet all their working capital needs.
5. Overdraft Against Life Insurance Policy – Banks have started offering loans based on flexible terms and conditions.
6. Home Loan Overdraft – This feature enables home loan borrowers to withdraw the excess sum paid towards their home loan to reduce the burden of interest.
What are the Pros and Cons of an Overdraft Facility?
| Pros | Cons |
|---|---|
| Instant Access to Funds – No need to wait for loan approval; you can withdraw funds immediately within your overdraft limit. | High Interest if Overused – While lower than credit cards, overdraft interest can still be expensive if it is frequently used. |
| Interest Only on Used Amount – You are charged interest only on the amount you actually use and for the time it is used. | May Lead to Overspending – Easy access to funds may encourage excessive borrowing and poor financial management. |
| No Fixed Repayment Schedule – You can repay the borrowed amount at your convenience, offering flexibility. | Repayment is Mandatory – Although flexible, the borrowed amount must be repaid, and delays may result in penalties. |
| Helps Cover Short-Term Financial Gaps – Useful for managing unexpected expenses or temporary cash shortages. | Overdraft Limit Restrictions – The bank sets a maximum limit, which may not always meet your financial needs. |
| Reusable Credit Limit – Once repaid, the overdraft facility can be used again, ensuring continuous access to funds. | Possible Additional Fees – Some banks charge maintenance fees, overdraft fees, or penalties for exceeding the limit. |
| Lower Interest Than Credit Cards – Overdrafts generally have a lower interest rate compared to credit cards, making them a cost-effective alternative. | Impact on Credit Score – Prolonged or excessive overdraft usage can negatively affect your creditworthiness. |
What are the Interest Rates and Charges on Overdraft Facility?
Though an overdraft facility feels more convenient, it should be remembered that the interest rates in general are greater than in any ordinary loan. The interest is calculated on a daily or monthly basis and there are some charges to be paid if the overdraft is not settled within a period of time. Many banks may charge a processing fee for obtaining the overdraft facility.How to Apply for an Overdraft Facility?
You can apply for an overdraft facility by following these steps:Check your eligibility
Submit your application
Provide all necessary documents
Understand the terms and conditions
Once approved bank will set an overdraft limit
What are the Things to Keep in Mind Before Applying for an Overdraft Facility?
Here are the things you should keep in mind before applying for an overdraft facility:Be sure to compare before choosing an overdraft option since interest rates vary from bank to bank.
Avoid using them excessively since high-interest charges will add up quickly if the amount is not paid back promptly.
Keep a good banking relationship so that when time calls, you will be better positioned to negotiate the terms and conditions.
Ensure that you understand the policies, especially regarding hidden charges or penalties.
Monitor Your Usage as it may tempt you, but overdrafts should be wisely used and repaid at the earliest.
