Bank Overdraft is a credit facility given to an individual against his or her assets as collateral with banks. This means that you have the convenience of borrowing on the same account that is used for your daily banking transactions. As collateral, one can offer house, insurance policies, bank fixed deposits, securities etc to banks. Interest rates charged and overdraft sanctioned by banks vary on each of the collateral.
The Benefits of an Overdraft
- An overdraft provides you with cash for unplanned expenses.
- It provides the comfort to access extra cash for emergencies.
- Customer can use as much of agreed overdraft limit. The total limit is always available to them for use.
- Banks charge one percent more than the rate payable on the fixed deposits for the overdraft against fixed deposits.
- Once you have an overdraft, you can conveniently increase or decrease your limit.
- This credit facility is secured by an asset and the rate of interest payable is much cheaper as compared to spending on credit cards
- Customer has the option of taking out insurance on their overdraft facility. This gives them peace of mind knowing that their loan will be settled in full in the event of disability, dreaded disease or death.
Collaterals used in Overdraft Facility & the Margin of Safety – the Banks Take
- Bank’s Fixed Deposits as Collateral: On fixed deposits, you are eligible to get higher percent of amount sanctioned (nearly 70%) as overdraft facility compared to home as collateral. When takes overdraft against fixed deposits, banks charge one percent more than the interest rate payable on fixed deposit scheme. If your fixed deposit is earning 9% interest income p.a. then you will be paying out 10% interest cost p.a. for the period you avail the overdraft.
- Insurance Policy as Collateral: On life insurance policy, the amount for overdraft is calculated on surrender value of life insurance policy.
- Overdraft against Salary: there are banks who selectively offer temporary overdraft facilities against salary of an individual( nearly half of the monthly salary .
- House & other Property as Collateral : The bank feels comfortable in approving limit up to 40 % – 50% of the value of the property
- Use of Equity as Collateral: Banks sanction percentage on stock , against current market price because Stock prices are volatile to market and economy of the country
How to apply for an Overdraft Facility
Process to apply for overdraft facility is similar to taking any other loan from banks. Banks charge a processing fee of 0.5% to 1% with a cap of Rs 25,000 along with collateral. This overdraft facility is approved for one year and the bank reviews value of assets as collateral every year.