Overdraft Facility: Interest Rates, Types, Eligibility & Application

An overdraft facility is a tool provided by numerous banks that allows individuals to take credit for more than the amount currently available in their bank account up to a certain limit. This helps individuals manage unexpected expenses or short-term cash flow issues without taking out a formal loan. The overdraft limit is predetermined and usually based on an individual’s financial profile, implying that the interest levied on the amount. 

With overdraft protection, the individual’s transactions will not bounce even if the account balance is below zero, allowing for zero penalties and maintaining a financial reputation. The interest rate on overdraft facilities varies from lender to lender. To use this facility wisely, monitoring your spending, ensuring timely repayments, and avoiding excessive reliance on this credit line is crucial. Proper management of an overdraft can offer flexibility without burdening you with unnecessary debt​.

What is Overdraft Facility?

An overdraft facility is a flexible credit option from banks. It lets you take out more money than you have in your account, up to a set limit. It helps people and businesses deal with short-term cash flow problems. You can avoid the hassle of applying for a traditional loan.

Quick answer about What is an Overdraft Facility?

Understanding How an Overdraft Facility Functions

An overdraft facility is a flexible financial tool that allows you to withdraw more money than you have in your bank account up to a pre-approved limit. Here’s how it works:

• Pre-approved Credit Limit: Banks set an overdraft limit based on your creditworthiness. You can withdraw funds beyond your account balance, but only up to this limit.
• Interest Only on Utilised Amount: Interest is charged only on the amount you use, not the entire overdraft limit. This makes it a cost-effective option for short-term needs.
• No Fixed Repayment Schedule: Unlike loans, overdrafts do not require fixed monthly repayments. Depending on your cash flow, you can repay the borrowed amount at your convenience.
• Immediate Access to Funds: An overdraft provides quick access to funds for urgent expenses, helping you manage cash flow issues without delay.
• Flexible Usage: You can use the overdraft facility as often as needed, provided you stay within your limit and repay the amount used.

Features of Overdraft Facility

• Pre-approved Limit
  Your bank sets the overdraft limit based on your financial profile. This means you can withdraw more than your account balance up to this limit, providing flexibility when needed.

• Interest on Utilised Amount
  Unlike traditional loans, overdraft interest rates are charged only on the amount you actually use, not on the entire limit, making it a cost-effective option for short-term borrowing.

• Flexible Repayment Options
  The repayment schedule is flexible, allowing you to pay back the amount at your convenience, which helps you manage your cash flow better.

• Overdraft Protection
  This feature ensures that your checks or payments don’t bounce even if your account balance is low, helping you avoid penalties and maintain your financial credibility.

Benefits of Overdraft Facility

• Emergency Fund Access
  The overdraft facility acts as an emergency fund, giving you quick access to money when needed without the hassle of applying for a loan.

• Avoidance of Penalties
  With overdraft protection, you avoid the fees and penalties associated with bounced checks or declined transactions, saving you money and stress.

• No Collateral Required
  Most overdraft facilities are unsecured, meaning you don’t need to provide any collateral to access this service, making it easier to obtain.

• Flexibility in Usage
  The overdraft can be used for any purpose, whether for personal expenses, business needs, or unexpected costs, offering you complete control over your finances.

Types of Overdrafts

There are various types of overdrafts available. Here are some of the most common types:

1. Overdraft Against Income

Specifically designed for salaried individuals, this facility allows you to overdraw from your salary account, often up to a multiple of your monthly salary. This overdraft facility is ideal for managing short-term financial needs and unexpected expenses.

2. Overdraft Against Home Loans

Some banks offer overdraft facilities linked to home loans, where the borrower can withdraw funds up to a certain limit. The overdraft interest rates are applied only to the amount withdrawn, providing a flexible option for managing large expenses.

3. Overdraft Against Equity

This type lets you take out an overdraft against your equity share investments. The limit is usually a percentage of the market value of your shares, offering a way to leverage your investments for immediate cash needs.

4. Overdraft Against Insurance Policy

This allows you to borrow against the surrender value of your life insurance policy, using it as collateral. The overdraft limit is typically a percentage of the policy’s surrender value, with interest charged only on the amount withdrawn. This option lets you access funds while retaining your insurance coverage, making it a practical choice for urgent financial needs.

Overdraft Facility: Interest Rate, Fees & Charges

Refer to the table below for a comparison between various lenders offering overdraft facilities:

Eligibility Criteria of an Overdraft Facility

Refer to the table below to check the general eligibility criteria of an overall facility:

Required Documents for an Overdraft Facility

The list of required documents to avail of an overdraft facility is mentioned in the table below:

How to Manage an Overdraft Facility?

It is essential to manage your overdraft facility carefully. Refer to the points below on how to effectively manage your overdraft facility:

Regularly Monitor Your Account

Keeping a close eye on your account balance can help avoid unnecessary overdrafts. Most banks offer mobile alerts or notifications that warn you when your balance is low, allowing you to take action before an overdraft occurs.

Repay Overdrafts Quickly

The faster you repay your overdraft, the less interest you’ll accumulate. Some banks offer grace periods, giving you a short window to return your account to a positive balance without incurring fees.

Consider Alternatives for Long-Term Needs

Overdrafts are best suited for short-term financial gaps. If you frequently rely on overdrafts, it might be worth exploring other options like a personal loan or a line of credit, which could be more cost-effective in the long run​.

Use Overdraft Protection Wisely

Overdraft protection can save you from high fees in case of accidental overspending. Linking your checking account to a savings account or setting up an overdraft line of credit provides a safety net. However, be mindful of any associated fees or interest rates.

Understand the Terms and Fees

Each bank has different policies for overdraft fees and interest rates. Ensure you understand the specifics of your overdraft facility, including any penalties for exceeding your limit or delayed repayments.

How to Apply for an Overdraft Facility

The following is the application process to avail of an overdraft facility:

Choose your Ideal Lender

Check the websites of different banks and the facilities offered by financial institutions or lenders that suit your requirements. Also, check their interest rates, fees and charges, and credit limits.

Eligibility Criteria

The eligibility criteria for applying for an overdraft facility vary from lender to lender. Hence, it is important to filter the options and choose a lender whose eligibility criteria you meet. 

Fill Out an Application Form

After selecting the ideal lender, visit their nearby branch. Ask their customer support team for an application form, where you must fill in your personal details, including yourself and your business.

Submit Your Documents

Your lender might ask you to submit documents related to you and your business. You must submit those documents to take advantage of the overdraft facility.

Credit Check

The lender will assess your creditworthiness before offering you an overdraft facility. Hence, it is essential to maintain a decent credit score.

Provide a Collateral or a Security

The lender might ask you to provide collateral or security in case of a higher credit limit. You can provide them with an FD, property documents, or any other asset. 

Account Setup

If your application is approved, the lender will provide you with their terms and conditions, which you should read carefully. After you read and sign the agreement, your account will be set up with an approved credit limit.

Frequently Asked Questions (FAQs)