What is an overdraft loan? Features, types and how it works

Flexibility is often of utmost importance in good financial management, especially when it comes to catering to any unexpected costs. An overdraft loan is such a financial instrument that, if used wisely, imparts this flexibility. This guide explains the fees, advantages, and important factors to consider before taking an overdraft loan.

Understanding overdraft loan

An overdraft loan allows people and businesses to take some amount beyond what they have in their respective accounts, up to a preapproved limit. Even in situations where there is not much money in the account, this instrument helps accomplish an urgent cash flow need. The total amount of overdraft relies on factors involving the relation of the borrowing party with the bank combined with the policies that the bank follows.

Features of overdraft loan

• Pre-approved credit limits: Each applicant has a different set ceiling which the banks use to edit the overdraft facilities.
• Interest payments: The interest would only be paid on the amount used, not the entire amount allowed.
• No penalties: Unlike regular loans, overdraft loans will not have prepayment charges.
• Flexible repayment: They can repay part or full amounts, whenever they can, without fixed EMIs.

Types of overdraft loan

1. Overdraft against property: In certain places, one could submit a property as collateral to avail of overdraft limits.
2. Overdraft against fixed deposits: In certain places, fixed deposits and life insurance policies can be used as collateral against getting an overdraft limit.
3. Overdraft against insurance policies: The target amount for overdraft loans is determined on the basis of the surrender value of the insurance policies.
4. Overdraft against equity: Banks fix a smaller percentage of overdrafts against shares' backing as collateral keeping in view the fluctuating nature of equity prices.

How does overdraft loan work?

An overdraft is where a certain amount of money which you have borrowed a certain agreed limit is made available to you over and above your available cash. The outstanding amount reduces with deposits made therein, and you might borrow again whenever the need arises. The borrower may repay in full or in part at any time. Interest is payable only on the amount used. The majority of overdrafts do not require collateral, as they are essentially unsecured.

In conclusion, while overdraft facilities provide financial flexibility, overdraft loans are also a burden on your resources, chargeable in the form of interest and fees. It is important to consider and understand the condition of the overdraft-to-be in regards to interest rates, fees, and payback conditions before taking it. An overdraft facility should only be viewed as a temporary financial solution, as timely repayment is critical to avoid incurring unnecessary debt.

(Note: Raising a loan comes with its own risks. So, due caution is advised)