Overdraft Facility: Smart things to know about it

Overdraft facility a type of short-term loan/ financial instrument that should be repaid in defined tenure as required by the financial institutions. An overdraft can be borrowed from almost every financial institution like the bank or NBFC.

It is a facility where some customers are pre-entitled to avail the overdraft facility by the lender, while some have to take approval from the concerned bank or the financial institution.

Under the facility, the lenders' levy interest rate that the borrower needs to repay, as per the bank's terms and conditions. The type of interest rate offered by the lender is fixed and not floating.

Important smart things that one should know about the overdraft facility:

1) It is a credit agreement made with a bank that allows an account holder to use or withdraw more money than what they have in their account, but it is limited to the approved limit.

2) The overdraft is awarded over a predetermined limit, which can vary for every borrower.

3) Overdraft is a line of credit that is mainly given based on the account holder balances, and as per sanctioned loans against assets such as bank FDs, shares and bonds offered as collateral.

4) The sanctioned overdraft limit and the interest charged will vary based on the nature of the asset offered as collateral.

5) Overdraft works like a pre-approved loan in which money can be withdrawn as and when required. The good thing is that the borrower needs to pay interest only on the amount borrowed and only for the time it was a borrowed. It is calculated daily and it is billed to the account at month-end. In case, where the borrower fails or defaults to pay the overdraft as per set schedule then the interest amount is added to the principal amount at the end of the month and then interest is calculated on the new principal amount.

6) Prepayment charges in the overdraft are nil, unlike the loan where a prepayment charge is levied.

7) The available overdraft facility can help individuals or small businesses with short term cash flow issues, although the negative balance needs to be repaid within a month.

8) You do not pay the overdraft through Equated Monthly Installments (EMIs) as you have to do so in the case of loans that you avail from the banks. It is a facility which can be repaid whenever you have the money. You can repay whatever amount you like whenever you like. However, if the lender demands a repayment, then you will have to fulfil that demand.

Types of Overdraft

An overdraft facility can be granted to a borrower on a secured (one where you pledge collateral (asset)) or unsecured basis. Here are types of overdrafts

1) Overdrafts against House

2) Overdrafts against Fixed Deposits

3) Overdrafts against Insurance Policy

4) Overdrafts against Equity

5) Overdraft against Salary

Pre-entitled customers: There account balance turns negative and the overdraft facility is activated automatically when an extra amount is withdrawn from their account.

Customers who require lender's approval: They have to avail the overdraft facility have to submit their request to the concerned lender either through the official website or in writing.