Yes, an overdraft is a type of loan provided by a lender to its customers either in their savings account or current account. An overdraft allows the borrower to make payments from their accounts even if their account balance is zero or below the mandated threshold. When the overdraft is sanctioned by a bank to its customers, it is called a Bank Overdraft.
Overdraft Limit Explained: Meaning, Benefits and Types
An Overdraft Limit is a pre-approved limit of a credit line that can be utilised by customers of a bank or NBFC to borrow or withdraw funds from their overdraft accounts upon which interest is charged by the lender. The overdraft limit has to be renewed annually except in the case of a Drop-line Overdraft Facility (DOD).
Types of Overdraft Limits
There are two types of Overdraft Limits-
1. Secured Overdraft Limit
These are usually provided to customers against assets pledged as collateral. The assets acceptable as collateral vary across lenders but usually include property, fixed deposits, life insurance policies, and equity.
Related Article: What is Overdraft Facility?
2. Unsecured Overdraft Limit
Unlike a secured overdraft limit, an unsecured OD limit does not require an asset to be pledged as collateral. Examples of an unsecured OD limit include- overdraft facility in the current account, Overdraft Facility in the savings account, etc.
Usually, the specified limit granted in this case is lower than the limit granted in a secured overdraft facility due to lack of collateral.
How does an Overdraft Limit work?
An overdraft limit works in the following way:
- A customer usually approaches a lender (bank or NBFC) for an Overdraft Limit.
- Banks/NBFCs then check the creditworthiness (credit score and repayment history) of the customer and an overdraft account is opened for the eligible customers. The lenders may also provide an overdraft limit in their existing current account.
- Account holders can then withdraw money within the specified limit from their accounts whenever there is a working capital requirement. Lenders usually charge an interest on the amount withdrawn from the account.
- Once the customer has adequate cash, they can deposit funds in their Overdraft account to settle the outstanding balance.
Benefits of an Overdraft Limit
An Overdraft Limit has the following benefits for an overdraft account holder:
- It helps optimise the cash flow of a business.
- The borrower does not have to pay monthly instalments on the money overdrawn from the account.
- The interest charged is calculated only on the amount utilised, and not the entire sanctioned limit.
- Multiple withdrawals are allowed from the overdraft account.
Also Read OneNDF Articles:
- ICICI Bank InstaOD
- What is the Overdraft Limit?
- Difference Between Cash Credit and Overdraft Facility
- Difference Between Loan Against Property Vs Overdraft Facility
- What is Debt Financing, Types and How does it Works?
- Difference Between Secured and Unsecured Loan
- Unlock Financial Potential: Lease Rental Discounting Guide
- Building a Strong Credit Profile for Business Loan Approval
FAQs
What is the overdraft limit in India?
An Overdraft Limit is a credit line facility provided to borrowers by Banks or NBFCs to address their working capital requirements. The limit varies across lenders and on the credit score of the borrowers but it can go up to 2-3 times their earnings/salary.
Is it good to have an overdraft limit?
Yes, an OD limit can help optimise the credit utilisation ratio of a business. Apart from that, it is significantly beneficial for small businesses that may not have consistent income and can help them make necessary payments for smooth operations.
Is an overdraft loan good or bad?
While any sort of loan increases the liability of the firm, an overdraft loan can be considered good when compared with a term loan since there is no fixed schedule to repay the borrowed amount.
What are the risks of an overdraft?
One of the major risks of an overdraft is that it can lead to very high interest payments if used for long-term borrowing needs. Since an OD is designed only for addressing short term borrowing needs of businesses, it comes with a comparatively high interest rate when compared with a long-term loan.
Is overdraft a loan?
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