Bank overdrafts are financial arrangements offered by banks to individuals and businesses, providing them with a flexible line of credit. An overdraft allows account holders to withdraw or spend more money than they currently have in their accounts up to a predetermined limit set by the bank.
This article explores the concept of bank overdrafts, how they work, their advantages and disadvantages, and their common associated features. Understanding bank overdrafts is crucial for managing personal and business finances effectively, as they serve as a convenient and accessible source of short-term credit.
What is a Bank Overdraft?
A bank overdraft is a financial arrangement wherein a bank permits an account holder to withdraw funds exceeding their available account balance. This facility is generally linked to current or savings accounts and is governed by a predetermined limit set by the bank, based on the customer’s financial profile and banking relationship.
Unlike traditional loans, where a fixed amount is disbursed and repaid in EMIs, overdrafts are more flexible. The borrower can access funds as and when required, and interest is charged only on the amount used.
Types of Bank Overdraft Facilities
Banks offer different types of overdraft options catering to diverse financial needs:
1. Overdraft Against Salary
This facility is extended to salaried individuals who maintain salary accounts with the bank. The overdraft limit is often based on a multiple of the net monthly salary and is subject to the bank’s terms. This option helps employees manage financial shortfalls between pay cycles.
2. Overdraft on Savings Account (Jan Dhan Yojana)
Accounts opened under the Pradhan Mantri Jan Dhan Yojana can avail of overdraft facilities. The overdraft amount depends on the account's activity and average balance, usually capped after satisfactory usage for six months. Aadhar linking is mandatory, and one family member is eligible.
3. Overdraft Against Fixed Deposits (FD)
Banks allow customers to avail overdraft against their fixed deposits, usually up to 90% of the FD value. This option allows liquidity without breaking the deposit. Interest is charged at a marginal rate above the FD interest rate.
4. Overdraft Against Time Deposits from SBI
The State Bank of India offers overdraft facilities against time deposits like TDR, STDR, and RD accounts. Customers can avail limits ranging from a minimum to a considerably large amount based on the deposit value, with flexible repayment terms.
5. Overdraft Against Insurance Policies
Some banks allow customers to avail overdraft by pledging life insurance policies. The loan-to-value ratio is based on the surrender value of the policy, generally up to 85%. Repayment tenure and interest rates vary depending on the bank’s policy.
Features of Bank Overdraft
Bank overdraft facilities offer several key features that provide flexibility and financial assistance to account holders. These features include:
Approved Limit of Credit: In business lending, banks provide overdraft facilities with fixed limits that vary from borrower to borrower.
Interest Rate: Interest on overdrafts is charged only on the amounts used by borrowers, unlike traditional loans, which charge interest on the entire sanctioned amount.
No Charges on Repayment: Unlike traditional loans, there are no charges for repayment in overdraft facilities.
Flexible Repayment: Overdraft repayment is not structured as EMIs, offering borrowers the flexibility to repay according to their cash flow.
Minimum Monthly Payment: Borrowers usually need to make a minimum monthly payment, covering the interest on the borrowed amount.
Joint Borrowers Allowed: Overdraft facilities can accommodate joint account holders, providing additional flexibility and accessibility.
Short-Term Credit: Overdrafts offer short-term credit, typically needing repayment within 12 months or less.
Interest Accrual: Interest accrues on the overdraft amount for its use, ranging from a few days to several weeks.
Bank's Repayment Tenure: The bank determines the repayment tenure and retains complete authority over the account and its usage.
RBI Regulations: Current accounts and cash credit accounts are eligible for a maximum overdraft of Rs. 50,000 per week as per RBI regulations.
Advantages Of Bank Overdraft
Bank overdrafts offer several advantages, making them a preferred financial tool for managing cash flow and meeting immediate funding requirements.
Flexible Cash Management: Bank overdrafts provide flexibility in managing cash flow , allowing borrowers to access funds as needed.
Immediate Access to Funds: Borrowers can quickly obtain funds to address urgent financial needs without waiting for loan approval.
Interest Only on Utilized Amount: Interest is charged only on the amount withdrawn from the overdraft facility, offering cost-effective financing.
Minimal Documentation: Acquiring a bank overdraft typically involves minimal paperwork, simplifying the application process.
No Collateral Requirement: Unlike traditional loans, bank overdrafts generally do not require collateral, making them accessible to a wider range of borrowers.
Flexible Credit Option: Overdraft facilities provide a flexible credit option that can be utilised as needed, offering convenience and adaptability.
Cost-Effective Financing: Borrowers incur interest expenses solely on the amount utilised from the overdraft, making it a cost-effective financing solution.
Ideal for Managing Sudden Expenses: Bank overdrafts are ideal for managing sudden expenses or unforeseen cash needs, providing businesses and individuals with timely financial support.
