What is an Overdraft Facility?

Published on: 9 February 2017

Modified on: 10 April 2023

What is meant by Overdraft facility?

Overdraft facility is a credit line that is sanctioned to an individual against their assets. For example, you can mortgage your house with a bank and get a loan amount sanctioned against it.

If your house is worth 1 crore, then the bank might sanction you a loan of 50 lakhs after evaluating your repayment capabilities.

Why is there a need of an Overdraft Facility?

There are situations in life where in even the money saved for emergencies is not sufficient and this may lead to individuals in a dilemma. A lot of people keep 3 months to 6 months of expense aside on being advised by their financial consultants, however this might not be handy when there is an urgent need of cash.

This is where Overdraft facility comes in. Overdraft facility is a great way to raise funds for short-term if used wisely.

Usage of the overdraft money

The money is not disbursed immediately. You can keep withdrawing money from this overdraft account. It works similar to an approved personal loan. The interest will be charged from the day you borrow the loan. You can keep on borrowing and repaying it till the bank allows you to do so. The interest charged is 12-14 percent per year.

Assets that can be used as mortgage

Following can be offered to banks as assets: –

• Insurance polices
• Fixed Deposits
• Shares
• Bonds

The rate of interest varies for different collaterals.

The process

The process is similar to taking any other loan. You can offer a variety of collaterals to bank against your loan. There are pros and cons associated with different kinds of collaterals that you might offer. For example taking an overdraft against a property gives you a larger line of credit, however the time to evaluate is large. In case of fixed deposits as collaterals the process is much faster. Similarly the returns for life insurance properties are not good.

Depending upon the collateral, you should choose the limit. There is also a fee with a cap of 0.5 to 1 % charged while an overdraft is being granted.

Should one go for an Overdraft facility?

Overdraft facility is meant for disciplined individuals. If you use it for short-term trading in stocks, commodities, etc, it may backfire. If you lose in these risk oriented measures, then you will have to pay the entire amount along with the interest incurred. Also if you fail to do so, then the collateral is liquidated. So choose very carefully.