What is the Meaning of Overdraft?
Overdraft is a financial instrument in which the money can still be withdrawn from the current or savings account, even if the account balance goes below zero. It is a type of extension of monetary limit offered by banks and that money is said to be ‘overdrawn’. An authorized overdraft limit is assigned for each customer depending on their relationship with the bank. The customer can withdraw money up till the assigned limit. Banks do charge interest rate on the money withdrawn in form of overdraft.
Interest Rate on Overdraft Facility
The interest rate on overdraft facility offered by private and public sector banks shall vary from lender to lender and depends on required loan amount, repayment tenure and relationship with the respective bank or financial institution.
Features of an Overdraft Facility
- Overdraft account is a facility that can be availed by maintaining any bank account (savings or current)
- Minimum age criteria is 18 years and maximum up to 65 years for bank account holders only
- Several private sector banks are now offering this facility for both salary and savings account holders
- The money extension is granted on the basis of customer’s account value, repayment history or credit score
- It is short-term credit provided by the bank that needs to be paid within the stipulated time limit, usually 12 months or even lesser
- Credit amount or overdraft attracts interest for the time of use which can be from a couple of days to a few weeks
- Repayment tenure is decided by the bank and it has full authority over the account and its use
- As per the RBI regulations, current accounts and cash credit accounts are eligible for a maximum of Rs. 50,000 per week
Overdraft is a significantly useful feature provided by the banks, as it offers aid to businesses in terms of cash flow to meet their working capital expenditure. Businesses often have to wait for the payments from their clients and this results in delayed payments from their side as well. With the support of overdraft in their current accounts, businesses can sign cheques for their clients beyond the available funds in their account. This prevents cheque dishonour and maintains the reputation of the business, as well..
Benefits of Bank Overdraft
- Interest rate is charged only on the utilized amount
- Overdraft is a Short-term borrowing that is revised every year
- Cash flow management becomes convenient
- Helps to meet urgent cash crunch requirements
- No collateral or security is required by the bank
- Less paperwork is required for credit sanctioning
Difference between Cash Credit and Overdraft
|Interest rate is lower as compared to Overdraft||Interest rate is comparatively higher|
|Cash credit loan can be availed on hypothecation of stocks and inventory||Overdraft amount can be availed based on credit history, relationship with bank and investments like FDs, insurance policies, etc.|
|Cash Credit should be availed for business purposes, only||Overdraft can be used for any purpose, including business related requirements|
|Loan amount is based on the volume of stocks and inventory||Loan amount is based on financial statements and security deposited|
|Cash Credit does not reduce over time||There is a monthly reduction in case of Overdraft|
|To avail Cash Credit, new account needs to be opened||Overdraft facility is availed on existing account of the applicant (account holder)|
|Cash credit loan can be availed for minimum 1 year||Overdraft facility can be availed for shorter tenure like a month or quarter, maximum for 1 year|
|Cash credit loans can be availed by individuals, retailers, traders, manufacturers, distributors, companies, partnerships, sole proprietorship, LLPs, etc.||Overdraft facility can only be availed by account holders of the respective bank|
|Cash credit is sanctioned based on the business performance and market situation||Overdraft is sanctioned based on financial statements and credit history|
Frequently Asked Questions
How is OD interest calculated?
The overdraft interest rate is calculated by the method of average daily balance method in which the overdraft interest is calculated by considering the balance of a current account at the end of each day or tenure.
What is overdraft in banking?
A bank overdraft is a credit line in which bank offers a borrowing limit that can be withdrawn even if your bank account balance is below zero.
What is the difference between bank overdraft and bank loan?
The main difference between bank overdraft and bank loan is that in overdraft the interest rate is paid only on the utilized amount, whereas in bank loan you have to pay interest rate on the whole amount.
Is overdraft or personal loan better?
Both are useful to overcome immediate cash crunch situations. Personal loan can be availed by any financial institution, however overdraft can be only availed from the bank, wherein you have your existing current or savings account. Interest rate paid on personal loan is on total borrowed amount but in case of overdraft the interest rate is paid only on the utilised amount.
How do I repay my overdraft?
You can repay your overdraft by getting a 0% money transfer card and transferring funds from your credit card to your current account. You can repay by fixing a repayment tenure from a bank or by paying it as per your convenience in form of EMI or lump sum amount before specified time by the lender.
What happens if I can’t pay my overdraft?
If you are unable to repay the overdraft amount on time, then the bank is liable to deduct the outstanding amount plus the interest rate from your current or savings account linked with the bank.