De-jargoned: The benefits of overdraft

If you have a good record with the bank, you can be offered an overdraft facility. Find out its benefits and pitfalls

Hemant Mishra/Mint
Hemant Mishra/Mint

An overdraft is like a loan against a security, but here you can withdraw and repay without paying a penalty. Most banks offer it with salary and current accounts, and fixed deposits (FDs). Some lenders also offer it against assets such as shares, bonds and insurance policies. 

How it works

Banks limit the overdraft amount depending on the collateral. In case of FDs, and salary accounts, the limit is higher. Against an FD of Rs2 lakh, an overdraft of 80% (Rs1.60 lakh) can be had. Some lenders set an FD limit too. For instance, Bank of Baroda offers it if the FD is at least Rs10,000 and for 12 months. For shares and debentures the limit can be 40-70% of the value.

Interest rate on this credit varies by assets. With FDs, it is usually 1-2% above the term deposit rate. Against securities such as shares, the interest rate could be linked to marginal cost of funds-based lending rate (MCLR) along with the spread. For example, interest rate on State Bank of India’s overdraft against shares is 12.1% per annum (1-year MCLR: 9.1% and spread of 3%). 

Interest is calculated on the amount borrowed and the number of days. You can also opt for part-payment. Say, you take a credit of Rs50,000 for 20 days, part-pay Rs40,000 in 10 days and the rest 10 days later, then you will pay interest on the full amount for just 10 days. For the Rs10,000, interest will be charged for 20 days.

For salary accounts, overdraft may be capped at 3 months’ salary. Conditions still apply. For example, HDFC Bank asks for a minimum salary of Rs15,000.

Is it for you?

It is quick source for extra funds, but use the facility only in an emergency. Lower interest can be tempting but non-repayments or delay can hit your credit score. Compared to overdrafts, personal loans are usually for longer duration and involve payment in equated monthly instalments (EMIs). Their interest rates, however, may be higher, and there is processing charge and prepayment penalty.

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