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Home >Money >Personal Finance >Is credit card better than salary overdraft?

Lenders generally target young salaried borrowers who could be facing a cash crunch towards the end of a month. But several banks offer a similar product – salary overdraft. Adhil Shetty, CEO, Bankbazaar.com, explains the criteria to take a salary overdraft and things a salaried should watch out for before opting for it.

Banks probably have a loan for every occasion, and a salary overdraft could be considered one of the handiest. While it is an admittedly convenient way to access emergency funds for the short term, it is essential to understand how overdraft on salary works to utilise it appropriately.

A salary overdraft is a form of revolving credit that you can avail of on your salary account. Simply put, the salary overdraft works like a credit card. Depending on the terms of the facility offered on your account, you will be allowed to withdraw a particular amount over and above the balance in your salary account when you need it.

Each bank has its own set of eligibility parameters that determine the extent of overdraft they allow. Typically, the credit line offered by banks ranges from one to three times your net monthly salary; however, some banks may restrict this to 80-90% of your salary or their fixed overdraft limit, whichever is lower.

For instance, some banks may cap the overdraft at 3-5 lakh, while others may allow only a much smaller amount of around 1-1.5 lakh regardless of the borrower’s income. Some banks may even allow an overdraft of only 10,000-25,000 depending on their policies.

The repayment options also vary from one bank to another, but most provide an automatic sweep facility whereby the amount payable is auto-swept as and when there’s sufficient balance available.

The overdraft facility is extended only to some select salary account holders based on their eligibility and credit history. One will have to apply for the overdraft facility, usually via net banking, and some processing fees may be involved.

In most cases, this may not be charged upfront but only after sanction of the overdraw limit. There may also be an annual renewal fee if you wish to revolve the credit beyond one year.

It is important to remember that an overdraft on salary is expensive. Regardless of whether it is simple interest or daily reducing balance, the average rate of interest can be anything from 1-3% per month or 12-30% per year, depending on the bank. Coupled with the processing fee and penalties in case of missed payments, this can be a very expensive form of credit.

Unlike a credit card, it does not come with the benefits of exclusive offers or reward points that can be redeemed. Unless you need hard cash, you may be better off with a credit card that offers all these benefits and more at a fraction of the cost.

Moreover, with credit cards, you get an interest-free period every month to repay whatever amount you have utilised. This makes credit cards a more cost-effective option compared to the overdraft on the salary.

(Do you have personal finance queries? Send them to mintmoney@livemint.com and get them answered by industry experts)

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