Overdraft Facility

What is the Overdraft Facility?

This facility allows businesses to withdraw money from a savings or current account even when its balance reaches zero. The concerned financial institution sets a specific withdrawal limit for an account holder over and above his/her existing balance. If, for instance, an individual holds Rs. 7,5000 in his/her savings account and the bank sanctions an overdraft limit of Rs. 25000, that account holder can withdraw Rs. 1 Lakh in total. 

Such limit depends on an individual’s repayment history, credit score, and existing relationship with the financial institution. Businesses can utilise this loan facility to finance their cash flow requirements conveniently. Several businesspersons consider availing the bank overdraft loan facility over term loans to resolve working capital needs of their enterprises. 

Alternatively, with KredX, businesses can efficiently optimise their working capital needs by leveraging unpaid bills of debtors to avail a cash advance in no time. 

What Are the Different Types Of Overdraft Loans?

Financial institutions primarily offer two types of overdraft facilities – 

• Secured Overdraft Loan:

Individuals or businesses can access the overdraft facility by collateralising any asset, like a term deposit, real estate property, shares and bonds. Apart from that, financial institutions also provide overdrafts against a borrower’s savings or salary accounts. 

Under the Pradhan Mantri Jan Dhan Yojana, for example, account holders are allowed an overdraft limit of up to Rs. 10,000. One needs to link the Aadhaar card with the bank account to avail this scheme’s benefits.

In the case of overdrafts against any other collateral, the withdrawal limit, as well as the interest levied, depends on the value and nature of the pledged asset. 

• Unsecured Overdraft Facility:

Businesses can also access unsecured overdraft facilities, i.e. financing without any collateral. Applicants need to satisfy stringent eligibility criteria to avail this line of credit. That’s because the risk a financier is assuming in extending an unsecured business overdraft loan is significant compared to its secured counterpart. The cost of such a loan is also higher. 

How Does An Overdraft Loan Work?

This credit facility works in the following manner – 

• An individual applies for an overdraft loan with a financial institution for business or personal use. 
• The bank or NBFC assesses the credibility of such an applicant based on his/her credit score, repayment history, relationship with it, etc. to determine the eligibility, the overdraft limit to be sanctioned, and also the interest rate. If it is a secured overdraft facility, this lending institution will also take into account the collateralised asset’s value. 
• Once approved, a new account is created with the sanctioned amount credited, or the withdrawal limit on such applicant’s current or savings account is increased. 
• The borrower can withdraw any amount they need to fund different financial obligations from the extended limit. 
• The interest is calculated daily on the utilised amount. This borrower has to repay the used amount along with such interest at the end of each month. In some cases, the borrower can repay the total utilised amount along with interest at the end of repayment tenure. 

What Are the Pros of An Overdraft Loan?

Individuals can enjoy the following benefits by availing this credit facility – 

• Address Emergencies Easily

Organisations with a business overdraft loan can access external funding anytime. It allows businesspersons to address any emergency financial obligation in their enterprises with ease. Individuals can also use this loan facility to mitigate personal emergencies. 

• Working Capital Regulation

Businesses can streamline their working capital cycle efficiently by utilising this credit facility. They can use it to pay suppliers on time, finance daily operations, disburse wages, etc. 

• Reduce EMI burden

With a regular business loan or personal loan, the borrower has to pay interest on the entire sanctioned amount. It leads to higher total interest accrual, net amount payable, as well as the EMIs. 

In the case of an overdraft loan, businesses or individuals can pay interest only on the utilised amount and not the entire sanctioned limit. It reduces the interest payable and resultantly, the EMIs. 

What Are the Cons Of An Overdraft Facility?

The downsides of this credit option are – 

• Higher Costs

In the case of an overdraft loan, interest calculation takes place on a daily basis. Also, the interest rate and fee levied can be considerable when it’s an unsecured overdraft facility. In comparison, options like invoice financing service can be cost-effective for business finances.

• Stringent Eligibility Criteria

Financial institutions require applicants to satisfy stringent criteria to qualify for an overdraft facility. It’s more so the case with an unsecured loan. 

Alternatively, individuals can avail invoice discounting services from KredX by fulfilling minimum eligibility criteria and formalities to access a cash advance within 24 – 72 hours*. 

Nevertheless, it is essential to employ such an advance appropriately. It allows businesses to optimise their financial standing and improve cash flow.