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Understanding overdraft
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An overdraft is a financial facility that allows individuals and businesses to withdraw more money than what is available in their current account, up to a certain limit. It acts as a short-term credit option to manage cash flow gaps or unexpected expenses. Understanding how overdrafts work, their types, fees, and protection options is essential to use them wisely and avoid costly surprises. If you’re considering other financing options, you can check your business loan eligibility to explore tailored funding solutions.
What is overdraft?
An overdraft is a credit facility that lets you withdraw more than the available balance in your bank account, up to an approved limit. Interest is generally charged on the amount used for the time it remains outstanding. Other charges may also apply.
For example, if your account holds Rs. 10,000 and you withdraw Rs. 15,000 using an approved overdraft, the overdrawn amount is Rs. 5,000. Interest applies to this amount, subject to the facility’s terms.
An overdraft can help cover short-term cash shortages, but regular use without a repayment plan can increase borrowing costs.
Overdraft terms explained
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These terms explain how an overdraft works and the conditions that may apply.
Term Meaning Overdraft limit The maximum amount the bank permits you to borrow beyond your available account balance. Amount used The outstanding amount borrowed through the overdraft. Interest is generally calculated on this amount. Arranged overdraft An overdraft approved in advance, with an agreed limit, interest rate and conditions. Unarranged overdraft An account becoming overdrawn without approval or exceeding its approved limit. The bank may reject transactions or apply charges, subject to applicable terms and rules. Collateral An asset pledged as security for the overdraft. Not every facility requires collateral. Lien A lender’s right to retain or restrict access to an asset or deposit as security, subject to the agreement. Surrender value The amount payable when an eligible insurance policy is ended early. It may help determine the borrowing limit for an overdraft secured against that policy. Minimum monthly payment Any minimum amount payable each month under the facility’s terms. Some overdrafts require regular interest payments and separate principal repayments. Revolving credit Credit that can be drawn, repaid and used again within the available limit, while the facility remains active.
Types of overdraft
Arranged overdraft
An arranged overdraft is a pre-approved facility set up with your bank. It comes with an agreed credit limit and specific terms regarding interest rates and fees. You can use the overdraft whenever needed, knowing the limits and costs upfront. This option offers better control and usually lower charges than unarranged overdrafts.
Unarranged overdraft
An unarranged overdraft happens when you withdraw beyond your account balance without prior approval or exceed your arranged limit. It is often treated as a breach of terms, resulting in higher fees and penalties. Unarranged overdrafts should be avoided due to the costly implications and negative impact on your credit rating. To avoid surprises and explore easier financing, you may want to check your pre-approved business loan offer available to you.
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Types of overdraft by security
Overdrafts may be secured against an asset or offered based on income and eligibility. The approved limit depends on the lender’s assessment and the facility’s terms.
| Type | How the limit is determined |
|---|---|
| Against property | Based on the lender’s valuation of eligible property, repayment capacity and the permitted loan-to-value ratio. |
| Against an insurance policy | Based on the surrender value of an eligible policy and the lender’s permitted lending margin. |
| Against shares and mutual funds | Based on the value of approved investments and applicable lending margins. Market movements can affect the available limit. |
| Against salary | Based on salary credits, account history and eligibility. This is generally income-based rather than secured against an asset. |
| Against a fixed deposit | Based on a permitted percentage of the eligible deposit’s value, with a lien marked on the deposit. |
Features of an overdraft facility
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- Flexible borrowing limit: You can access funds up to the agreed overdraft limit.
- Interest charged on used amount: Interest applies only to the amount you have overdrawn, not the full limit.
- Repayment terms: You can repay the overdraft at any time, reducing interest costs.
- Linked to current account: Overdrafts are typically tied to your existing bank account for easy access.
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Who can get an overdraft?
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Individuals and businesses may qualify for an overdraft based on income, repayment capacity, credit history, account conduct and any security offered. Eligibility and available facilities vary by bank.
Applicant Common route Salaried person A salary-linked overdraft, with the limit based on income, salary credits and eligibility. Business owner A secured or unsecured business overdraft, assessed using financial records, cash flow and banking history. Eligible asset holder An overdraft secured against an accepted asset, such as property, a fixed deposit, investments or an eligible insurance policy. Jan Dhan account holder An overdraft of up to Rs. 10,000, subject to scheme eligibility and the bank’s assessment. Offering security does not guarantee approval or a particular limit.
How to get an overdraft
The application process varies by bank, but generally involves these steps:
- Choose the facility: Compare account-linked and secured overdrafts based on your needs, eligibility and available assets.
- Submit your application: Provide the requested KYC, income and account records, along with security documents where applicable.
- Complete the assessment: The bank reviews your repayment capacity, credit history, account conduct and any proposed security.
- Review the offer: Check the approved limit, interest rate, fees, repayment conditions and renewal or review requirements before accepting.
- Use and repay responsibly: Stay within the available limit and meet interest and principal repayment obligations. Some facilities may be repayable on demand.
How overdraft interest is calculated: an example
Overdraft interest is generally calculated on the daily outstanding balance and charged periodically. Where the amount and rate remain unchanged, an illustrative calculation is:
Interest: Amount overdrawn × annual interest rate × days outstanding ÷ 365.
For example, suppose your approved limit is Rs. 5,00,000 and you use Rs. 2,00,000 for 10 days at 12% p.a.
Calculation: Rs. 2,00,000 × 12% × 10 ÷ 365 = approximately Rs. 658.
| Amount used | Days outstanding | Interest at 12% p.a. |
|---|---|---|
| Rs. 2,00,000 | 10 | Rs. 658 |
| Rs. 2,00,000 | 30 | Rs. 1,973 |
| Rs. 5,00,000 | 10 | Rs. 1,644 |
Figures are rounded to the nearest rupee and assume a constant balance, unchanged rate and a 365-day year. No borrowing interest applies to the unused limit, although other facility charges may apply. The rate is illustrative and is not a Bajaj Finance offer.
Overdraft fees and charges
The cost of an overdraft includes interest and any applicable facility or transaction charges. Check the bank’s fee schedule and sanction terms before accepting.
| Charge | What it covers |
|---|---|
| Interest | Generally calculated on the daily outstanding amount and charged periodically. |
| Processing or arrangement fee | Setting up the facility. It may be fixed, linked to the limit or waived. |
| Renewal or review fee | Reviewing or renewing the facility, where applicable. |
| Overlimit charges | Charges for exceeding the approved limit, where permitted. The bank may instead reject the transaction. |
| Payment return charges | Applicable charges when a cheque, mandate or other payment is returned unpaid. |
| Security-related costs | Valuation, legal, documentation or other costs for secured facilities, where applicable. |
Overdraft protection options
Some banks offer linked-account arrangements to help cover payment shortfalls. Availability, transfer rules and charges vary.
| Option | How it works |
|---|---|
| Linked account transfer | Moves available funds from another eligible account, automatically or through an arranged instruction. |
| Fixed deposit sweep-in | Uses funds from a linked deposit to cover a shortfall. Premature withdrawal conditions may affect interest earned. |
| Linked approved credit facility | Draws from an agreed credit limit where the bank supports this arrangement. Interest and other borrowing charges apply. |
A sweep-in from your own deposit uses your savings; an overdraft creates borrowing. Neither guarantees that every payment will be honoured.
Pros and cons of overdraft
| Pros | Cons |
|---|---|
| Access funds when needed within an active, approved limit. | Approval, continued availability and renewal depend on the bank’s terms. |
| Draw and repay flexibly within the available limit. | Some facilities have scheduled limit reductions or are repayable on demand. |
| Bridge short-term gaps between receipts and payments. | Persistent use can increase debt and leave less cash for future expenses. |
| Interest is generally charged on the amount used. | Fees may apply even when little or none of the limit is used. |
| Repayments can restore borrowing capacity. | The available limit may fall following a review or a change in security value. |
Overdraft vs cash credit
Overdraft and cash credit are revolving facilities that generally charge interest on the outstanding amount. Cash credit is primarily designed for business working capital, while overdrafts serve a wider range of borrowers and purposes.
| Feature | Overdraft | Cash credit |
|---|---|---|
| Typical borrower | Individuals and businesses. | Businesses needing working capital. |
| Basis of assessment | Income, cash flow, account history, credit profile and any security. | Working capital requirements, financial position and eligible current assets. |
| Security | May be secured or unsecured. | Commonly secured against stock and receivables; additional security may be required. |
| Available borrowing | Subject to the sanctioned limit and facility conditions. | Commonly limited to the lower of the sanctioned limit and drawing power. |
| Review and renewal | Depends on the product and agreement. | Usually subject to periodic review and renewal. |
| Use of funds | Restricted to the purpose permitted by the agreement. | Generally intended for approved business operating needs. |
Overdraft vs term loan
An overdraft allows repeated borrowing within an available limit. A standard term loan provides funds for a defined period, with repayments following an agreed schedule.
| Feature | Overdraft | Term loan |
|---|---|---|
| Access to funds | Draw, repay and redraw within the available limit and terms. | Usually disbursed once, although some loans use staged disbursements. |
| Interest calculation | Generally based on the daily amount outstanding. | Generally based on the outstanding disbursed principal under the agreed calculation method. |
| Repayment | Interest payments and principal repayment follow the facility’s terms; repayment on demand may apply. | Scheduled instalments, commonly including principal and interest. |
| Reuse of repaid funds | Usually possible while the facility remains active, subject to the available limit. | Generally unavailable without a separate borrowing arrangement. |
| Typical use | Short-term or fluctuating funding needs. | Planned expenditure requiring repayment over a defined period. |
When to use an overdraft and when not to
An overdraft can help bridge a temporary cash shortage when you have a clear repayment source. For longer-term spending, compare financing with a repayment schedule that suits the investment.
| When an overdraft may help | When another option may be more suitable |
|---|---|
| Covering a short gap caused by a delayed customer payment. | Buying machinery or property that requires funding over several years. |
| Meeting temporary, fluctuating expenses within an agreed budget. | Covering recurring losses without a realistic repayment plan. |
| Providing a backup for unexpected costs permitted under the facility. | Borrowing continuously at the full limit, leaving little room for further needs. |
| Managing payments until an expected receipt arrives. | Funding expenses that would exceed the approved limit or breach the facility’s terms. |
Tips on how to pay off an overdraft effectively
- Monitor your account regularly to avoid unexpected overdrafts.
- Budget carefully to reduce reliance on overdraft facilities.
- Repay overdrafts as soon as possible to minimise interest charges.
Consider alternative financing options if you need longer-term funds.
Conclusion
An overdraft can be a useful financial tool when used responsibly, offering flexibility and quick access to funds. By understanding the types, features, fees, and protections available, you can manage your overdraft effectively and avoid unnecessary costs. For more substantial funding needs, consider applying for a business loan to support your financial goals.
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Frequently Asked Questions
Overview
What is the maximum limit one can typically get on an overdraft?
There is no universal maximum overdraft limit. The bank assesses your income or business cash flow, existing debt, credit history, account conduct and any eligible security. The approved amount also depends on the product’s limits and lending policy. Offering collateral does not guarantee a higher limit.
Does an overdraft have prepayment charges?
Charges depend on the facility. Some overdrafts allow repayment without prepayment charges, but reducing the outstanding balance and permanently closing the facility may have different conditions. Check the sanction letter for repayment, closure and notice requirements before accepting the offer.
Can joint account holders get an overdraft?
Some banks offer overdrafts to joint account holders, subject to product eligibility and account-operation requirements. The bank may require all relevant holders to consent and sign the agreement. Confirm who can draw funds and who is responsible for repayment before accepting the facility.
Can I get an overdraft on a savings account?
Yes, where the bank offers a suitable facility and you meet its eligibility requirements. Examples include certain salary-linked overdrafts and eligible Jan Dhan overdrafts. A savings account does not automatically include borrowing rights; the bank must approve the facility and its limit.
What is the Jan Dhan overdraft limit, and who is eligible?
Eligible PMJDY account holders can access an overdraft of up to Rs. 10,000. Bank criteria commonly include an age of 18 to 65 years, satisfactory account operation and required identification checks. The facility is generally available to one eligible account holder per household. Confirm the assessment and account-linking conditions with your bank.
Are there RBI rules on overdraft accounts for businesses?
Yes. For customers with aggregate banking-system exposure below Rs. 10 crore, the specified account-maintenance restrictions do not apply. At Rs. 10 crore or more, eligibility generally depends on the bank holding at least 10% of aggregate exposure or aggregate fund-based exposure. Exceptions apply, including provisions for the largest lenders. These are account-maintenance rules, not automatic borrowing entitlements.
What happens if my bank can no longer maintain my overdraft account?
Where the bank becomes ineligible under the RBI’s account-maintenance rules, it must notify you promptly and within one month of identifying the issue. Conversion to a collection account or closure must be completed within three months of identifying the ineligibility, rather than three months after notification. Ask the bank how outstanding borrowing will be handled.
What is a collection account under the RBI overdraft rules?
A collection account primarily receives funds, with restricted outgoing payments. Receipts must generally move within two working days to the borrower’s designated account. Statutory dues and amounts owed to the account-holding bank may be debited first. It does not provide the same transaction freedom as an unrestricted account.
Can I get an overdraft against gold?
Some lenders offer revolving facilities secured against eligible gold. The sanctioned amount depends on valuation, applicable lending limits and the lender’s product terms. Check the interest calculation, charges, repayment requirements and circumstances in which the lender may enforce its security before pledging gold.
Can I get an overdraft under the MUDRA scheme?
Yes. Eligible MUDRA working capital finance can include an overdraft facility, with access through a MUDRA Card where offered. Availability and approval depend on the participating lender and business assessment. Funds must be used for the permitted business purpose under the sanction terms.
How do I close an overdraft account?
Ask the bank for the total closure amount, including outstanding principal, accrued interest and applicable charges. Settle the dues and submit the required closure request. Obtain written confirmation that the facility is closed, and check that any lien or pledged security has been released. Paying the balance alone may not close the facility.
How is overdraft interest calculated if my balance changes every day?
Interest is generally calculated on each day’s outstanding balance and added together for the billing period. At an illustrative 12% p.a., using Rs. 1,00,000 for five days and Rs. 2,00,000 for another five days gives approximately Rs. 493 in interest, assuming a 365-day year. Actual charges depend on the bank’s calculation method and terms.
What can I do if my bank charges me incorrectly on an overdraft?
Raise a written complaint with the bank, identifying the disputed charge and attaching relevant statements and sanction terms. Keep the acknowledgement and response. If unresolved or unsatisfactory, check eligibility for escalation through the RBI Complaint Management System under the applicable Ombudsman scheme. Follow its current waiting periods and filing deadlines.
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Bajaj Finance Limited has the sole and absolute discretion, without assigning any reason to accept or reject any application. Terms and conditions apply*.