What is Bank Overdraft Facility , Meaning and Interest Rates

Overdraft is a credit facility that allows you to withdraw funds from your current or savings account even if your bank balance is zero. Many financial institutions, including banks, provide this feature. An overdraft facility is a short-term loan that must be repaid within the time frame specified by the lender.

This guide explains what is overdraft and how it works.

What Is the Process Of Overdraft?

An overdraft provides account holders with financial flexibility. It helps them pay for expenses even when they are short on cash. It can potentially avoid embarrassing situations and assist customers in maintaining relationships with corporate parties.

Account holders can submit a written application to their banks to activate this facility. Account holders can also activate the feature by visiting their bank in person or applying online. Banks have the discretion to either accept or reject such an application. Towards specific categories of accounts, these services are made available by default. The customer must pay a one-time handling fee when the bank accepts a request.

This credit facility is distinct from others. First and foremost, the bank establishes a specific credit limit for each customer. Furthermore, this service is not free; banks charge interest on overdrafts. This interest rate is calculated daily. It is crucial to note that the account owner will only need to pay the interest on the borrowed amount, not the total threshold range. Banks don't charge pre-closure penalties for this facility. Furthermore, joint account holders are also eligible for an overdraft facility by co-applying for the same.

Overdraft Protection

Overdraft protection works by connecting your current account to another deposit account, a credit card, or a line of credit. When you extract more money than you currently have in your current account, money is immediately transferred from the linked savings account to your current account to ensure the transaction is completed.

A per-transfer fee may apply, but it may be significantly less than the penalty for overdrawing your account. Because overdraft fees are so high, many consumers choose overdraft protection.

Types Of Overdrafts

An overdraft facility can be given to a borrower on an unsecured or secured basis. A secured overdraft is one in which collateral is pledged (asset). If you cannot pay back your overdraft, the lender may sell your assets to recoup as much as possible. You will be responsible for paying the difference if the collateral resources don't compensate for the cost of the withdrawn amount in the overdraft. Overdrafts are of the following types:

Overdraft On Property

An overdraft facility is provided against your residence as collateral. Overdraft facilities are also available to home loan customers who require funds to settle their current home loan repayments. Before accepting the house as collateral, the property is assessed, surveyed, and valued. 

Overdraft funds are lent against property as collateral and are not disbursed immediately as a result. The permitted overdraft amount is typically 40%-50% of the property's value. Your repayment capacity and credit history are also considered while providing an overdraft against the residence as collateral.

Overdraft Against Fixed Deposits

Overdrafts against Fixed Deposits (FDs) are easier to obtain than overdrafts against your residence. One of the causes is that property assessment takes time. In any case, an overdraft against FD is also advantageous for the lender because the customer's fixed deposit account is with the lending institution, and the lender knows the customer much better. If you take out an overdraft against your FD, you will be eligible for a high proportion of the sanctioned amount, approximately 75%. If you keep your fixed deposit as collateral, the rate of interest charged is also lower. Banks typically charge 2% more interest than the interest you earn on the fixed deposit.

Overdraft On Insurance Policy

If you use your insurance plan as overdraft collateral, the sanctioned amount is determined by the surrender value of your insurance policy. The Loan to Value of the insurance plan is greater than the LTV of FDs, implying that you will receive more funds from the bank if you put your insurance policy as collateral instead of your FD of the same amount.

Overdraft On Savings Account 

Despite being a fairly new concept in the country, overdrafts on savings accounts have grown in popularity thanks to government support. All Pradhan Mantri Jan Dhan Yojna savings accounts are entitled to an overdraft of ₹5,000, or four times the monthly minimum balance (whichever is lower). This feature is only available to one member of a family after the accounts have been satisfactorily utilized for a period of six months. The facility is provided to the family's earning member, preferably a woman. An Aadhar card must be linked to the account.

Overdraft Against Salary

Overdrafts against salaries are also available from banks for salaried individuals. It is possible to have an overdraft limit of up to 2-3 times your salary, but this tends to vary by bank. To meet the criteria for this type of overdraft, you must possess a salary bank account at the bank in question. This type of facility is also known as a short-term loan facility.

Advantages Of Overdrafts

This facility can protect the customer's reputation. The following are some of the benefits of using this option:

Check Bounce Prevention

This solution prevents checks from being bounced. Consequently, the client can maintain fair credit scores with a clear payment record.

Timely Payments

It also aids account holders in making timely payments on overdue invoices. This way, clients avoid any delayed remittances, despite having a negative balance.

Ease of Application

An account holder can choose this option by filling out a simple form in person or digitally at the bank's website. The facility requires very little paperwork.

There Are No Pre-Closure Fees

Unlike other types of loans, an overdraft facility does not enforce an early payment penalty upon the account holder.

Minimal Interest

The financial institution only charges interest on the amount overdrawn. This, too, is imposed only till the amount is repaid.

Provides Convenience

Overdrafts can be made anytime, as required, as long as the deal is not revoked by the bank.

Conclusion

When you need money, the overdraft facility can be very beneficial. Banks also establish realistic payback terms to give leeway in repayment of the overdraft loan. But before utilizing this service from the bank of your choice, conduct proper research on overdraft facilities before establishing the limit. One will be granted only one line of credit under the overdraft facility, which must be paid off consistently.