Gaps in your cash flow don't wait for you to submit a new loan application. An overdraft loan is specifically designed for circumstances such as a client's late payment, an unforeseen medical expenditure, or a seasonal decline in revenue. An overdraft facility gives you a standing credit line that you may access anytime you need it, and you only pay interest on the amount you actually use, in contrast to a term loan where you borrow a big sum and repay it in predetermined EMIs.
What is an overdraft loan, therefore, and how does it actually operate? In this blog we will go through everything you need to know about overdraft facilities in India. It is included in this guide, including what an overdraft loan is, how it operates, current interest rates, eligibility, and the accurate application procedures for both personal and business use.
What is an Overdraft facility
To put it simply, an overdraft is a credit facility connected to your savings, current, or salary account that allows you to take out more money than your account balance up to a predetermined amount known as the overdraft limit. Therefore, you can still withdraw up to Rs. 2 lakh if your account balance is nil and your bank has approved an OD limit of Rs. 2 lakh.
Although an overdraft loan, also known as an OD facility or an OD loan, functions more like a flexible credit line than a one-time payout, it is still technically a loan. Banks and NBFCs provide overdraft protection against a variety of securities, including property, fixed deposits, payroll accounts, and even GST-based business turnover.
Overdraft limit meaning
The greatest amount your bank permits you to withdraw above your account balance is known as the overdraft limit. Based on your income, collateral, or banking relationship, this cap is determined at the time of sanction and is reviewed (and occasionally changed) at each yearly renewal.
How does an overdraft facility work?
Here’s how an Overdraft facility works
Depending on your income, banking relationship, or the amount of the collateral you provide, the bank may approve an overdraft limit.
You can use checks, online banking, or UPI-linked withdrawals to take out any amount up to that cap as much as you'd like.
Only the amount you have actually taken out and the number of days it is still outstanding are subject to interest charges on the overdraft facility; the entire authorized maximum is not.
The majority of overdraft accounts are renewed once a year, provided the bank examines your account behavior and payback history.
This is the core answer of how an overdraft facility works.
Types of overdraft facilities
Secured vs. unsecured overdraft
A fixed deposit, real estate, gold, or other valuables serve as collateral for a secured overdraft. Interest rates on secured OD facilities, which are typically just 1% to 2% more than the yield on the underlying asset (such as an overdraft against an FD), are more alluring due to the bank's reduced risk.
Collateral is not needed for an unsecured overdraft. Based on your revenue and transaction history, it is usually extended against your business banking relationship or salary account. Interest rates on unsecured overdrafts are significantly higher than those on secured options since the bank is assuming greater risk.
Personal overdraft vs. Business overdraft
An overdraft facility for personal use, also known as a personal overdraft, is typically connected to a salaried person's savings or pay account and is intended for short-term costs, travel, or medical crises. In contrast, a business overdraft facility is secured by a current account, GST reports, or business collateral and is intended to finance working capital, such as purchasing inventory, paying vendors, or bridging receivables. Overdraft restrictions for businesses are often higher and are evaluated more carefully in relation to turnover and repayment capabilities.
Overdraft facility interest rate: How much does it cost?
The type of overdraft facility, the collateral given, and the lender's benchmark rate all have a significant impact on the interest rate. Here's the general range you may anticipate based on rates released by major banks:
Overdraft against fixed deposit: Because the bank's risk is low, it is usually 1% to 2% more than the interest rate on the underlying FD.
Overdraft against property (Secured Business OD): 9% to 14% annually, depending on the loan-to-value, the applicant's profile, and the lender.
Unsecured salary-account or Insta-OD facilities: Usually between 15% and 18% annually, it is occasionally provided as a fixed daily or monthly rate.
GST or turnover-based business overdraft: Rates are typically based on an external benchmark rate plus a spread, and they differ significantly amongst lenders.
There are two things that should be made clear: first, the actual rates are determined by your credit profile, your relationship with the lender, and the benchmark rates that were in effect at the time of sanction; always check the current rate directly with the bank before applying. Secondly, these are indicative ranges that were created using publicly available bank information. Second, in response to a commonly asked question, respectable lenders only charge interest on the percentage that is utilized.
Overdraft loan interest calculation
How is overdraft interest determined, then? The majority of banks calculate overdraft loan interest using a straightforward formula: (outstanding utilized amount × relevant interest rate × number of days utilized) ÷ 365. Unlike fixed-EMI term loans, where the interest schedule is predetermined, early repayment, even in part, instantly reduces the interest you owe because it is based on a daily decreasing balance.
Overdraft facility feature
Interest rate only on the amount used, not the sanctioned limit
During the term, funds may be regularly taken out and reimbursed without having to reapply
Repayment flexibility dependent on your cash flow; no set EMI structure
It can be unsecured (salary/turnover-based) or secured (FD, property, gold).
Annual renewal, contingent upon an account conduct review by the bank
Frequently has little to no processing cost, particularly for secured overdrafts.
Overdraft facility Eligibility criteria
For salaried people: a consistent salary credited to the account, bank-set minimum income requirements, and a good credit score
For an OD against FD: possession of a qualified fixed deposit, usually with a minimum balance and residual tenure requirements
For business overdraft: minimum business vintage (often two to three years), regular banking or GST transaction history, and, frequently, Udyam/MSME registration or audited financials
For overdraft against property: possession of unencumbered real estate that can be used as collateral
How to apply for Overdraft Facility Online:
Are you curious about how to apply for an overdraft facility or obtain one online without going to a branch? Nowadays, the majority of banks allow current clients to apply online for an overdraft loan in a few easy steps:
Open the mobile app or web banking portal for your bank.
Select the appropriate OD product (against FD, salary account, or business overdraft) by navigating to the loans or overdraft area.
Select the account or deposit to link, or upload the necessary paperwork for an unsecured facility.
Examine the terms, interest rate, and sanctioned limit displayed by the bank.
Accept the terms; for a secured OD, the overdraft account is usually launched immediately, or for unsecured facilities, after a quick assessment.
Overdraft vs. Term loan
It all comes down to structure when comparing overdrafts and term loans. With a term loan, the entire approved amount is disbursed up front, and you repay it over a predetermined period of time through fixed EMIs. Interest is paid on the entire principal, including the portion you haven't yet used. In contrast, an overdraft only charges interest on the amount you use, giving you a limit to take from as needed. Term loans are ideal for significant, one-time purchases like real estate or equipment. Overdrafts are ideal for managing working capital and other recurrent or erratic short-term needs.
Benefit of Overdraft facility
Both salaried people and business owners choose overdraft loans because of their advantages, which include:
• Only pay interest on the amount you actually use, not the entire approved amount.
• You can repeatedly withdraw and repay within the limit without having to reapply each time you need money.
• Quicker access to cash as opposed to repeatedly requesting a loan
• Assists in balancing erratic financial flows, particularly for commercial overdraft customers handling working capital.
• Compared to unsecured personal loans, secured overdraft facility fees and interest rates are frequently lower.
Disadvantages of Overdraft facility
• Compared to secured loan products, unsecured overdraft interest rates may be higher.
• If money is easily accessible, it may lead to excessive borrowing if it is not closely monitored.
• Limits are typically reviewed, and the bank may decide to lower or remove them.
• If you default on a secured overdraft, your collateral, gold, real estate, or FD, is at risk.
Overdraft Loan Repayment
There is no set EMI plan for overdraft payments. As long as the outstanding balance remains within your approved limit, you are free to return any amount at any time. Nevertheless, banks usually demand that the account demonstrate credit turnover on a regular basis and anticipate that the overdraft will be reduced to zero or examined upon renewal. If the underlying FD matures and isn't renewed with the overdraft, the facility for OD against a fixed deposit is typically automatically reduced or closed.
FAQs
1. What is an Overdraft facility?
A credit line connected to your bank account that allows you to take out more than your available balance, up to a pre-approved overdraft limit, is known as an overdraft facility. Interest is only assessed on the amount taken out.
2. Is Overdraft facility a loan?
Yes, it is a type of interest-bearing loan that is set up as a flexible, revolving credit line as opposed to a term loan's one-time lump-sum disbursement.
3. What are the types of Overdraft facilities?
Overdrafts can be used for either personal or business purposes, and they can be secured (against FD, property, or gold) or unsecured (against salary or business banking relationships).
4. Overdraft facility vs. personal loan: Which is better
For one-time, planned costs, a personal loan is preferable since it provides a fixed lump sum with EMIs. When you have recurring or erratic short-term needs and don't want to pay interest on money you haven't used yet, an overdraft is a better option.