All You Need to Know About an Overdraft Facility for Your Financial Goals

Are you a business owner? Do you know about the overdraft facility? If not, we've got you covered. Business owners often find themselves in circumstances where they need extra funds to keep the business running successfully. Such problems can cause business operations to slow down or stop, which is devastating news for any business,  whatever the size. Any interruption in business means money lost. When you, the business owner, run out of funds, you can quickly rely on an overdraft (OD) facility. 

A Brief Explanation of What is Overdraft Facility

An overdraft facility is a form of credit that allows you to borrow money from your bank even if insufficient funds are in your account. Many banks offer this option to help cover unforeseen bills or cash flow needs. This is especially beneficial for businesses. Consider it a flexible loan with a defined limit to which the bank agrees you can borrow. This limit is beyond what you presently have in your savings or current account. 

With an overdraft, you only pay interest on the amount you use, not the total limit set by the bank. The borrowing limit changes depending on your relationship with the bank and account history. This makes an overdraft useful for short-term needs. This is because it allows you to immediately access more funds. However, it is critical to utilize it wisely, as banks charge interest on overdrawn funds until you repay it. Now that you understand the overdraft facility meaning, let's explore some of its features.

Understand the Features of Overdraft Facility

• A bank overdraft facility is similar to a pre-approved loan. The bank establishes a precise limit to which you can overdraw your account balance. You can withdraw that amount as needed.

• The allowed limit and interest rate for the overdraft facility are determined by your normal account balance, financial stability, collateral type, and other factors.

• The bank only charges interest on the amount you use and for the period it is borrowed. It is calculated daily and invoiced to you monthly.

• While the overdraft facility interest rate is predetermined, it may rise if you fail to repay the amount due.

• You may repay the amount as soon as you have the funds, either in full or in installments. There is no prepayment penalty or EMI concept, as with loans.

• While there are no minimum monthly repayments, you should pay it back as soon as you can because it affects your credit score.

How Does an Overdraft Facility Work?

The OD facility enables you to withdraw more funds than the amount available in your bank account within the set limit. This implies you can use it even if your account balance is zero. It is a short-term loan agreement that can assist you in meeting more immediate or direct capital needs. The scope of the overdraft facility is determined by the credit limit that the bank has pre-approved. This is based on its relationship with the customer. You can withdraw a small amount of money or the entire credit limit at once. An OD facility varies from a business loan in that you pay interest only on the amount you withdraw, not the whole sanctioned credit limit. 

The overdraft facility interest rate varies per bank. Banks also charge overdraft charges for accounts that are not maintained. While there are no prepayment penalties, banks may impose higher interest rates if you fail to make payments on time. The repayment period is 12 months, but a business loan can last up to 10 years. In contrast to loans with fixed-term EMIs, you can repay in a lump sum or installments. 

Almost all financial institutions offer an overdraft facility to their customers. However, the amount and rate of interest depend on many factors, including:

• The borrower’s profile

• Relationship with the bank 

• Credit score rating and financial history 

• Repayment capacity 

Know the Calculation of Interest on Overdraft Limits

In an overdraft facility, you are only charged interest on the amount you have used. You may withdraw money from the OD account several times up to the sanctioned limit. You can also deposit funds into the account whenever you like. As a result, the account will receive many withdrawals and deposits. That is why, for overdraft limits, interest is calculated using the 'Average Daily Balance' method.

The average daily balance method calculates interest by taking the balance of a current account at the end of any given day or period. The formula is:

Average Daily Balance * APR * Days in Billing Cycle / 365

Now, APR is the interest rate. 

Overdraft Interest Rates Charged by Certain Major Banks and Non-Banking Financial Institutions

Types of Overdraft Facility Explained

1. Overdraft against Property

A bank overdraft facility is available against your home as collateral. Home loan customers who require funds to settle their existing home loan repayments can also apply for an overdraft. Before the residence is accepted as collateral, it is assessed, valued, and surveyed. Overdraft funds are offered as collateral and are not disbursed immediately. The sanctioned overdraft amount is often between 40% and 50% of the property's worth. Your credit history and repayment capacity are also taken into account when providing an overdraft against your home as collateral.

2. Overdraft against Fixed Deposits

Obtaining an overdraft using Fixed Deposits (FDs) and life insurance policies as collateral is simpler than obtaining an overdraft using your property as collateral. One of the reasons is that property appraisals require time. In any case, an overdraft against FD benefits the lender because the customer's FD account is with them, and the lender knows the consumer better. You will be eligible for a greater percentage of the approved amount, roughly 75%, if you use an overdraft against your fixed deposit. The interest rate will also be lower if you retain your FD as collateral. Typically, banks charge 2% more interest than what you earn on it.

3. Overdraft against Insurance Policy

If you hold your insurance policy as overdraft collateral, the amount sanctioned is decided by the policy's surrender value.  The loan-to-value of the insurance policy is higher than the LTV of Fixed Deposits, which means you will receive more money from the bank if you hold your insurance policy as collateral rather than your FD of the same amount.

4. Overdraft against Equity

Equity is not the preferred alternative for collateral, although it is feasible to obtain an overdraft facility using it. The reason is that equity is market-dependent; hence, its value varies. This is why the percentage approved for an overdraft against equity as collateral is lower.

5. Overdraft against Salary

Banks also provide an overdraft facility for salaried employees against their salary. You can receive an overdraft limit of up to 2-3 times your earnings, though this varies per bank. To apply for such an overdraft, you must have a salary account with the bank. Such a facility is also known as a short-term loan facility. Banks' borrowing restrictions are primarily based on their overdraft balance sheets.

Comparison Between an Overdraft Loan and a Term Loan

An Overdraft Facility is Available on Which Bank Accounts?

Initially, current accounts used for business transactions were granted the overdraft account facility. However, most bank account holders can now take advantage of this facility, regardless of the type of bank account they have. Overdraft facility is available on:

• Current account 

• Salary account 

• Deposit account

• Savings account 

What are the Advantages of a Bank Overdraft Facility?

Financial Flexibility and Convenience

An overdraft facility provides a flexible approach to getting short-term credits to suit your immediate business needs. It is also more convenient because you do not have to submit time-consuming documentation or go through the approval process for a business loan. Loan refusal rates are also higher, although the OD facility is widely available with the majority of bank accounts.

Quick Access to Funds

An OD facility eliminates the hassle of obtaining a business loan, which might take weeks to be approved and credited to your account. You can use the OD facility at any moment if you have a bank account with the relevant bank.

Cost-Effective Borrowing Option

The interest rate on the overdraft facility is less than that of a business loan. Additionally, there is no prepayment penalty. The interest is only levied on the amount withdrawn from your bank account, making ODs a cost-effective way to get immediate credit. 

Improving Cash Flow Management

A bank overdraft facility can provide fast liquidity. This will improve overall cash flow management in business operations regularly.

Eligibility and Application Process for an Overdraft Facility

1. Eligibility Criteria for OD Facility

• Age: Any individual who is 21 to 65 years old.

• Minimum Income threshold: Differes as per the bank.

• Bank account: The person needs to have an active bank account.

• Credit score: A good credit score is also an added benefit.

2. Required Documents

• Fully filled out application form and a passport-size photograph.

• Address proof such as Passport,  Voter ID card, Driving License, and Utility Bills.

• Identity proof such as a Passport, PAN card, voter ID card, License, and Aadhar card.

• Last 12 months’ bank statement.

• Age proof, such as a Passport or Class X certificate.

• Any extra documentation that the bank or lender asks for.

3. Application Process

If the bank does not provide a pre-approved overdraft limit, you can apply for one by completing the formal application and providing the necessary documentation. The application procedure can be started online, through mobile banking, or in person at your bank branch.

Conclusion

An overdraft facility is a great way to get funds when you need it right away. The withdrawal and repayment options are flexible, and interest is only charged on the withdrawn amount. However, you must do thorough research on them before applying. A Personal Loan from Hero FinCorp provides similar perks. Interest rates are fixed, loan amounts are available based on need and creditworthiness, and repayment terms are customizable in budget-friendly EMIs. Contact us at Hero FinCorp now and enjoy hassle-free loan approval. 

FAQs

Which bank provides an overdraft facility?

Almost every public or private sector bank in India offers an overdraft facility to its customers. However, banks' minimum and maximum loan amounts, interest rates, and repayment terms may vary depending on the applicant's profile, financial history, and repayment capabilities.

Are overdraft facilities good or bad?

Individual financial situations determine whether overdraft facilities are regarded as good or bad. While they provide flexibility, misuse can result in excessive interest costs. Prudent management is required for their proper use.

How does an OD facility's interest get calculated?

Banks calculate interest on your OD Facility using the average daily balance method based on the amount you take from your account. 

What are the advantages of overdrafts?

Overdrafts are convenient to use since they are readily available. They do not have fixed repayment schedules and can assist in times of emergency.

What is the differentiation between a Term Loan and an Overdraft Facility?

A term loan offers a lump sum with defined repayment terms, but an overdraft facility provides a variable credit line with interest payable only on the amount utilized, allowing for intermittent repayments. 

What is the overdraft facility on FD?

Overdraft against Fixed Deposit enables account holders to take out funds against the value of their fixed deposit, providing a secured credit facility that uses the FD as collateral.