What Is An Overdraft?

Imagine that you need to make a sudden payment through your bank account but do not have enough balance. In such situations, the overdraft facility offered by banks can come in handy. An overdraft is a credit facility that banks extend to accountholders by allowing them to withdraw more than their balance in accounts. You need to have a savings, salary, current or cash credit account with a bank to avail of the facility.

Types Of Overdraft

• You can take a secured overdraft from a bank against your salary, fixed deposits, shares, life insurance policies or equity instruments.
• There are two types of overdraft—authorised and unauthorised.
• In the authorised version, there is an arrangement between the bank and the accountholder on the limit of the overdraft.
• In the unauthorised version, banks allow it even without any formal agreement. Where an overdraft exceeds the authorised limit, it is also counted as an unauthorised overdraft.

Main Features

• Banks charge an interest only on the overdraft utilised. For instance, if the bank allows you an overdraft of `2 lakh, but you use Rs 50,000, then the bank will charge interest only on Rs 50,000.
• Overdraft facility can be availed of at short notice with minimal paperwork and without collateral You can also take an unsecured overdraft without any collateral.
• Account balance, credit score and repayment history are some of the factors considered to determine the overdraft limit.
• An overdraft is usually allowed for shorter time periods, say, a week, month, or at most a year.

Should You Go For It?

• The amount of interest you pay on an overdraft is, typically, higher than the personal loan, though the upfront rate may be lower. This is because interest on overdraft is calculated using the average daily balance technique, due to which the effective payout increases.
• Overdraft is not viable for the long term and should be used for short-term cash flow needs.
• Overdraft interest could vary between banks, but one can take an overdraft only at a bank where one has an account.
• In case of joint borrowers, they are equally liable for repayment.