At a time when interest rates are rising, one needs to borrow smartly. For emergency needs, most individuals look at personal loans. However, an overdraft account in a bank can help to tide over any short-term financial needs and avoid liquidating other savings and investments.
A bank will allow an account holder to withdraw money in excess of what is available in his bank account. The credit limit is fixed by the bank based on the account holder’s balance. The rate of interest depends on the amount of the overdraft and the period.
Adhil Shetty, CEO, Bankbazaar.com, says an overdraft facility is typically connected to the borrower’s bank account, allowing the borrower to withdraw to a defined limit a sum over and above the balance in the account. “It is similar to revolving credit such as credit cards where you can use credit to a given limit, pay back your dues, and have your credit limit restored,” he says.
Personal loan or overdraft?
One of the biggest advantages of an overdraft facility is that the interest will be charged only on the amount withdrawn as compared to a personal loan where the interest is levied from the day the amount is disbursed. For availing personal loans, the lender will do background checks and verify the documents each time the borrower applies for a loan. In case of an overdraft, the documentation is done once and the borrower can overdraw money multiple times from the same account up to the amount sanctioned for overdrawing.
Loans offered in the form of overdraft facility allow borrowers multiple withdrawals of any amount from the sanctioned limit, repay the drawn amount and borrow again, according to their needs. The interest is charged only on the drawn amount till its repayment.
Sahil Arora, senior director, Paisabazaar, says while the interest component needs to be serviced each month, borrowers are offered the discretion to service the principal component as per their funds availability. “An overdraft facility is best suited for those facing frequent short-term cash flow mismatches. The higher repayment flexibility offered through overdraft facilities leads the lenders to charge higher interest rates than regular personal loans offered in the form of term loan,” he says.
What to look out for
Experts say while availing the overdraft facility is faster than personal loan, the borrower must be cautious. In case of a pre-approved overdraft account in a bank, the individual must keep a tab on the borrowing and repay regularly. Experts say unchecked borrowing can lead to a debt trap as the interest will keep piling up.
Borrowers having enough repayment capacity to repay the borrowed amount lump sum in a very short period, like less than three months, should opt for personal loan overdraft facility, says Arora. He adds that others should stick to regular personal loans offered in the form of term loan with fixed tenure and EMIs. “Most lenders charge fixed interest rates on personal loans, both term and overdraft facilities. Thus, once a borrower avails a personal loan, his interest rate would remain unchanged irrespective of the changes in the interest rate regime,” he says.
Borrowers must compare overdrafts by interest rate, processing fees and renewal fees. “See how the charges compare to other forms of borrowings that solve similar needs. For the salaried, credit cards may be similarly useful. For the self-employed needing flexibility with cash flow, an overdraft may be useful. Interest applies only to the credit you avail, and pre-payments are free,” says Shetty.
Overdraft rules
An overdraft facility is typically connected to the borrower’s bank account
Interest is charged only on the amount withdrawn in an account with overdraft facility
Borrowers can withdraw multiple times any amount from the sanctioned limit
Unchecked borrowing can lead to a debt trap as the interest will keep piling up
Compare overdrafts of different banks by interest rate, processing fees and renewal fees before zeroing in on one