Overdraft Account: Definition, Interest Rates, Types, and More

For both businesses and individuals, borrowing money is a part of life. When faced with financial hurdles in life, we all look for a way to borrow money to deal with the challenges at hand. Particularly when you have short-term financial needs and the loan interest rates are rising, opting for bank loans may not seem like a good option. This is where a bank overdraft facility comes to your rescue. 

An overdraft facility is best suited for individuals who face frequent cash flow mismatches but can repay the borrowed amount in a short period. In this complete guide, we will take you through various sides of bank overdraft or OD. 

What is an Overdraft?

Overdraft is a financial instrument using which you can withdraw money from your bank account (savings or current) even if the account balance is zero. Most banks and NBFCs (Non-Banking Financial Corporations) provide overdraft facilities to their account holders. 

You can also think of the overdraft facility as an extension of the credit limit provided by banks. Once you apply for a bank OD account, an authorised overdraft limit will be assigned to you based on your relationship with the bank. You can withdraw money up to the assigned limit and then repay the same back within a defined period. Basically, a bank overdraft meaning implies that the bank will allow you to borrow a certain amount when your account has no funds or insufficient funds to cover the withdrawal. 

As per the lender’s terms and conditions, you may also need to pay interest at a certain rate on the utilised amount from the total overdraft limit. The interest rate charged on the overdraft facility varies from one lender to another and depends on the account balance in your bank account and your relationship with the chosen bank. 

Also Read: All About Tax Deducted At Source (TDS)

Features of an overdraft facility

• An approved overdraft limit is given to OD account applicants. This limit can be different for each applicant. 
• A certain interest will be charged on the amount used from the sanctioned overdraft limit. It is calculated daily and is billed to the account at the end of each month. Failing to pay the interest timely as per the defined schedule will result in its addition to the principal amount. Then, the interest will be charged/calculated on the new principal.
• On repaying the amount borrowed through an overdraft, you need not pay any prepayment charges.
• There is no minimum monthly repayment limit related to the overdraft facility in general provided the amount you owe is within the sanctioned limit. Delaying the payment of an overdraft can affect your credit score. 
• A joint overdraft facility is also available with most banks. With this, you can take an overdraft with a joint applicant and then both of you will be responsible for the repayment of the debt borrowed. It also means that if one of you is unable to pay the used amount from the sanctioned overdraft limit, the other has to pay the entire amount. In case of default, the collaterals of both borrowers will be at stake, irrespective of their overdraft proportion.
• The overdraft repayment tenure is decided by the lender and it has complete control over the OD account and its usage.

How does an overdraft facility work?

It starts with you getting an OD account sanctioned from the bank. You will receive a certain overdraft amount or limit. Whenever you need funds, you can choose to withdraw the amount in your OD account up to the agreed limit. Once withdrawn, the amount will go into the overdraft and the outstanding on your bank account will increase. When you deposit funds, the existing outstanding decreases.

From the time you borrow until the repayment date, you need to pay a certain interest. Once you repay the borrowed amount with interest, you can again withdraw a certain sum as per your requirements, and the cycle continues.

You should also know that:

• You can repay the amount you borrowed whenever you can, either partially or completely.
• The lender can provide both collateral-free or secured overdraft (against an asset) facilities.
• The interest rate charged over the bank overdraft is also determined by the assets used as collateral or the funds in your account.
• Overdraft is a revolving, short-term credit facility. You can use it for your financial needs and then repay the amount timely to avoid hefty interest charges.

Recommended Read: Companies Act 2013: What All You Should Know?

Types of overdrafts

The following table covers different types of bank OD accounts:

Differences between a term loan and an OD account

Overdraft FAQs

Is an overdraft facility better than a personal loan?

Both these banking products can be used to deal with financial needs. While you can avail of a personal loan from any bank, an overdraft facility can only be availed of from the bank where you have a savings or current account.

What will happen if I fail to pay the withdrawn amount from my OD account?

On failing to repay the overdraft amount timely, the bank will be liable to deduct the outstanding amount along with interest from the linked savings or current account.

Does applying for overdraft affect credit score?

There is no major impact on the credit score when you apply for an OD account. However, it can have a negative impact in case you default in making timely repayments. 

Is a bank OD account a long-term liability?

In general, the repayment period of an overdraft is 12 months, which makes it a current liability. It can also be considered a short-term loan. 

Which bank(s) provides an overdraft facility?

Almost every private or public sector bank provides overdraft facilities to their account holders. 

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