Overdraft

Last Updated 21st Sep 2020

Overdraft Overview

  • Overdraft is extension of credit when the salary or saving account balance is zero.
  • Overdraft facility depends on the customer and bank relationship.
  • There are two types of overdraft- secured overdraft and unsecured overdraft.
  • Overdraft loan can be taken against salary accounts, savings account, or term deposits.
  • Bank overdraft allows you to meet short term funds requirements with a flexible repayment option.
  • In case of loans, overdraft is the deposit of surplus funds to save interest on loans.

What is overdraft?

Overdraft is a financial instrument to provide an extension of credit when the savings or current account balance reaches zero. Most of the banks offer an overdraft limit depending on the customer's existing relationship with the bank. Bank also charges the interest and fees on exceeding the overdraft limit of the accounts.

Generally, there are two types of overdrafts: Secured overdrafts and unsecured overdrafts.

Secured Overdrafts: Secured overdrafts are the overdrafts that are taken against one’s saving or current account.

Unsecured Overdrafts: The overdrafts that are not taken against any collateral are known as unsecured overdrafts.

Overdraft Facility

An overdraft facility allows customers to use or withdraw money from their account upto the approved limit. It works like an approved loan where the interest is charged only on the utilized amount. An overdraft facility helps individuals and self employed businessmen to resolve short term cash flow issues. The customers can avail of the overdraft facility through various platforms like a mobile app, internet banking, or visiting the bank branch. The features of availing overdraft facility are:

  • Credit Limit: The credit limit of every borrower varies from bank to bank. The limit is predetermined on the customer relationship with the bank.
  • Interest Rate: The interest rate of overdraft loan is calculated on the amount of overdraft used. The amount is calculated daily and billed at the month-end. In the failure of payment of overdraft limit on time, the penalty is added to the principal amount.
  • Prepayment Charges: There are no prepayment charges on using the overdraft facility.
  • Repayment: The credit taken through an overdraft facility is not paid in EMI’s. The customers can repay the overdraft loan cumulatively.

Meaning of Overdraft Account

The overdraft facility can be availed through any savings and current accounts. The eligibility for the overdraft limit is decided by the bank based on the customer’s repayment history and account balance. Here is an overview of the eligibility of different types of overdraft accounts.

  • Overdraft Facility on Loan: The overdraft facility provided by various banks and financial institutions can be utilised to reduce the amount of EMI on your loans. To use the overdraft facility, borrowers can utilise the surplus funds in the savings or current account of the loan taken. The surplus amount over EMI deposited in that account will be considered as a prepayment of the loan and can reduce the outstanding principal amount. As the outstanding amount of loan reduces, the amount of interest will be calculated on a lower amount, thus reducing the interest outgo of the loan as well. The surplus amount added in the overdraft account can be withdrawn at any time and the outstanding amount will be rebalanced accordingly.

    For instance, you have taken a home loan of Rs. 20 Lakhs for 15 years at an interest rate of 9.80%. The monthly instalment that you need to pay every month would amount to Rs 21,248. If you deposit the surplus amount of Rs. 30,000 in your account after 6 months then the principal quotient in next EMI would be Rs. 15,800 as against Rs 16,045.

  • Overdraft Facility on Savings Account: The overdraft facility became popular with the introduction of Pradhan Mantri Jan Dhan Yojna. Under this scheme, the individuals can avail of the overdraft up to Rs. 5000 or 4 times the value of accent balance. However, in the case of the new account holder to be eligible for a bank overdraft facility, the individuals need not only maintain a balance in their account but also do regular transactions for a stipulated period of six months. To avail of the overdraft facility under this scheme, the individual account must also be linked with the Aadhar card. The minors or individuals with Kisan Credit Cards are not eligible for the scheme.
  • Overdraft Facility on Salary Accounts: If the individuals want to avail of the overdraft facility on their salary accounts, the salary must be regularly credited to their account. The salary limits may range from Rs. 15,000- Rs. 25,000 depending on different banks. The individuals do not require any collateral for availing overdraft facility against their salary accounts and can avail credit upto 3 times the current salary.
  • Overdraft Facility against Deposits: Overdraft facility can be easily availed against term deposits as compared to other overdrafts that are taken against collateral like property. The documentation required is very minimal in this case as banks already know about their credit history, bank balance, etc. They can also get the benefit of getting higher values of overdraft limits against fixed deposits.

Overview of SBI Overdraft Facility

Overdraft Limit Rs. 25,000- Rs. 5 crores
Interest Rate 1% above the relative time deposit rate
Processing Fees Nil

Here are some other overdraft accounts against which you can take an overdraft loan:

  • Overdraft against an Insurance Policy
  • Overdraft against Equity
  • Overdraft against House

Difference between Overdraft and Loans

Overdraft facility is an arrangement between banks and customers under which banks allow customers to withdraw the money above their account balance depending on their relationship with customers. Loans, on the other hand, is the fixed amount of money borrowed for a fixed period.

This table summarizes the difference between overdrafts and Loans:

Point of difference Overdrafts Loans
What is it? Credit facility Borrowed Capital
Interest rate Interest is charged on the amount used Interest is charged on loan amount sanctioned
Calculation of interest rate Daily Monthly
Duration Overdrafts are short-term funds issued for a shorter duration Loans are taken to meet long term requirements of funds.
Types
  • Overdrafts against salary accounts
  • Overdrafts against term deposits
  • Overdrafts against savings accounts
  • Overdraft against house
  • Personal loans
  • Home loans
  • Gold loans
  • Business loans
  • Loan against property
Repayment Repayment is flexible and is not made monthly. Equal Monthly Installments, along with interest, is paid.

FAQs on Overdraft

What is meant by a bank overdraft?

Bank overdraft is the overdraft facility provided by the banks under which customers can withdraw money more than their account balance.

Is overdraft a loan?

Yes, an overdraft is a short term loan, different from other loans wherein customers are allowed to withdraw money above their account balance.

Who is eligible for a bank overdraft?

Individuals can avail of a bank overdraft facility, self-employed professionals, and enterprises on saving and current accounts.

What is the salary overdraft?

Salary overdraft is the bank overdraft facility or loan provided against the salary accounts of customers.

What is the advantage of an overdraft?

An overdraft is a flexible borrowing facility wherein individuals can withdraw money as and when they need it.

What is an overdraft account in a bank?

An overdraft loan or facility can be availed against different overdraft accounts like; Overdrafts against salary accounts, Overdrafts against savings accounts and Overdrafts against term deposits, etc.

Is overdraft a good idea?

An overdraft is a good option if you are looking for short term fund requirements or during any emergency.

*Terms and conditions apply. Credit at sole discretion of lender subject to credit appraisal, eligibility check, rates, charges and terms. Information displayed is indicative and from collected from public sources. Read More
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