Life can bring unexpected expenses, and sometimes, you may need cash in a hurry. Many people turn to personal loans when they find themselves short of funds, but with high interest rates, personal loans can quickly become expensive. One alternative worth considering is the overdraft facility that many banks offer, providing a lower-cost and flexible borrowing option. Let’s look at why an overdraft might be better than a personal loan and how to use it.
What is an Overdraft Facility?
An overdraft allows you to withdraw more money than you have in your bank account, up to a pre-approved limit. This facility is offered by both private and public banks on various accounts, including salary accounts, current accounts, and sometimes even fixed deposits (FDs). The overdraft works like a loan, but with a few key differences: it’s linked to your bank account and offers flexibility for taking and repaying money as needed.
Banks may also offer overdrafts against other securities like shares, bonds, or insurance policies. With this facility, you can borrow as per your requirement and repay when you have the funds available, making it a highly flexible option.
How to Apply for an Overdraft Facility
For some account holders, the overdraft facility is pre-approved. In these cases, you can simply start using it when needed. For others, you may need to apply and get approval from the bank. This application process can often be done online or by visiting a branch. Most banks may charge a small processing fee for initiating the overdraft, but the convenience and flexibility can make it worthwhile.
There are two types of overdrafts you can apply for:
- Secured Overdraft: You provide collateral, such as shares, bonds, an FD, or other assets like a house, to secure the overdraft amount.
- Unsecured Overdraft: For this type, no collateral is required. However, because it’s unsecured, the bank may approve a lower limit, and interest rates can vary depending on your creditworthiness.
How Much Can You Borrow with an Overdraft?
The borrowing limit depends on the bank’s policies and the type of collateral, if any. Typically, if you have good credit history and are securing the overdraft against a high-value FD or regular salary, banks can approve a limit of two to three times your monthly income or the collateral value.
For example:
- If you secure an overdraft against an FD, the bank may approve up to 90% of the FD’s value as an overdraft limit.
- If you apply based on salary or without collateral, the bank will evaluate your credit score and payment history before setting a limit.
Why Overdrafts Often Have Lower Interest Rates
One of the biggest advantages of an overdraft is the lower interest cost compared to personal loans or credit cards. Personal loans often have interest rates upwards of 12%–20% per annum, whereas an overdraft facility usually charges lower rates. Moreover, with an overdraft, you pay interest only on the amount you use and for the time you use it.
For example, if you withdraw ₹50,000 from your overdraft and repay it within a month, you’ll only be charged interest on that ₹50,000 for the month. With personal loans, you start paying interest on the full loan amount from the day the loan is disbursed, regardless of how you use it.
Key Benefits of Choosing an Overdraft
- Flexibility in Borrowing and Repayment: Borrow as per your needs and repay when you have the funds.
- Interest Only on Utilized Amount: Unlike a loan, you don’t pay interest on the entire approved limit, just the amount you use.
- Lower Interest Rates Compared to Personal Loans: Overdrafts usually come with lower interest rates than personal loans or credit cards, making them a cost-effective option for short-term needs.
- No Need to Withdraw Full Amount: With an overdraft, you have the freedom to withdraw only the amount you need, unlike personal loans, which disburse the full amount at once.
Is an Overdraft Right for You?
If you need short-term funds for unexpected expenses and have a bank account with an overdraft option, this facility can be a cost-effective alternative to a personal loan. It’s ideal for people who:
- Have an immediate cash requirement but prefer to repay quickly to avoid high-interest charges.
- Don’t want to take out a full loan amount and would rather withdraw only what’s needed.
- Have assets they can use as collateral for a higher credit limit (in case of a secured overdraft).
Overdrafts can help you manage cash flow without the lengthy application and higher interest associated with personal loans. Next time an unexpected expense arises, consider asking your bank about their overdraft facility – it may be just the financial backup you need.
