The interest rate on an overdraft account is calculated on the withdrawn amount from the total sanctioned limit. In other words, you pay interest on only the funds you borrow. So, if your overdraft limit is Rs. 80,000 but you have used Rs. 50,000, interest will be applicable on this used sum. OD interest rates can vary from bank to bank depending on factors like internal policies, current/savings account balance, OD amount required, and existing relationship with the lender.
Features
- Eligibility: Generally, an OD facility can be availed by anyone with a bank account (savings/current/salary) with the lender. However, banks may have specific age and income criteria in place.
- Approved credit limit: Each overdraft account has an approved credit limit, which varies depending on your creditworthiness, monthly income, and the bank’s policies.
- Interest charges: Unlike other loan products, where the interest is charged on the entire sanctioned sum, interest in an overdraft account is charged only on the amount you borrow from the sanctioned limit. While the rates vary from one bank to the next, interest is calculated on a daily basis.
- Repayment structure: OD repayments do not follow an EMI payment structure generally used for loans. Instead, you have the flexibility of repaying the sum depending on your cash flow. Lenders can also grant extensions based on the customer’s account value, credit score, and repayment history.
- Weekly limit: As per the latest RBI guidelines, the weekly overdraft limit for banks has been increased to Rs. 1,00,000. This rule applies to current accounts as well as cash credit accounts.
- Free prepayment: Generally, lenders do not levy a prepayment charge on OD accounts.
- Joint OD facility: If you have a joint account with an OD facility, you and your co-account holder are responsible for the debt, regardless of who uses it. In other words, if one borrower defaults on the OD account, the other account holder may have to repay the debt.
Pros & cons of an overdraft facility
Before opting for an OD account, it is essential to carefully consider the pros and cons of this facility. Here’s a quick overview of the advantages and disadvantages of an overdraft account:
Advantages of an overdraft account
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Disadvantages of an overdraft account
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Immediate access to funds aids in managing business cash flows and ensuring smooth business operations.
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OD interest rates tend to be higher than those of other credit products like term loans, increasing the overall cost of borrowing.
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Offers the financial flexibility to meet unforeseen expenses without applying for a formal loan.
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Continuous overdraft withdrawals without timely repayments can lead to debt accumulation and piling interest costs.
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Interest is calculated only on the utilised amount and not the total sanctioned sum.
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The sanction limit is determined by the bank based on your income and credit history. Applicants with low credit scores may have to pay a higher interest on ODs.
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OD accounts are perfect for short-term borrowing without collateral deposits.
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OD accounts are not suitable for long-term borrowing.
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The OD facility is useful to businesses as it helps them bridge the gap between payments and receivables, ensuring efficient working capital management.
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Excess reliance on overdraft withdrawals can signal underlying financial issues with the business.
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Types of overdraft (OD)
Banks extend overdraft benefits to various types of accounts to offer flexible credit to customers. Generally, lenders offer both secured and unsecured overdraft services. Here’s a list of the most common types of OD accounts:
- OD against salary
A salary account is opened by the company on behalf of its employees. If you are a salaried employee, you can avail of an overdraft facility against your salary. Generally, you can withdraw up to 2-3 times your monthly salary, but the OD limit varies from bank to bank. Some banks also have minimum salary requirements for such OD accounts. To avail of this facility, you should hold a salary account with the bank in question.
- OD on savings account
Certain types of savings accounts also come with overdraft support. All Pradhan Mantri Jan Dhan Yojna accounts are allowed an overdraft of Rs. 5,000 or 4x the monthly minimum balance (whichever is lower). However, this feature is available to one member per family and only if the account has been operational for 6 months. Some private banks also offer this service with their savings accounts.
- OD against fixed deposits (FD)
Banks also allow overdraft on FDs, typically sanctioning up to 75% of the saved FD corpus. The interest charge is just 1%-2% higher than the interest on the underlying fixed deposit. That said, specific bank policies on the sanctioned limit and interest rate can vary.
- Overdraft against property
Banks offer an OD facility against your property as collateral. This secured overdraft facility has comparatively lower interest rates and higher sanctioned limits. Usually, banks sanction up to 40%-50% of the property’s price as an OD.
- Overdraft against insurance
You can also use your insurance papers as collateral for an OD account. Here, the sanctioned limit depends on the surrender value of the policy.
Also read: Overdraft facility in bank
Conclusion
An overdraft account is a useful tool for managing cash flow requirements in the short term. Unsecured OD accounts can help MSMEs that may not own significant assets to secure regular loans. However, these accounts should never be used for long-term financial solutions. While they foster flexibility and liquidity, indiscriminate use of OD accounts without repayments can lead to debt pile-up.
If you wish to eliminate liquidity concerns, you can park your money in a non-cumulative Bajaj Finance FD. With the non-cumulative option, you can enjoy monthly, quarterly, or bi-annual payments to meet liquidity needs. Additionally, thanks to high interest rates of up to 8.85% p.a., you can easily boost your savings.
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