How borrowers will use overdraft facility intelligently ?
Sometimes eventuality fund won’t be enough to take care of a financial necessity. Though most people keep 3 to 6 months expenses aside as per their financial advisors advice, they generally need to raise money for a short period of time to meet an emergency.
Many of them turn to their banks for an overdraft against their assets to raise short-term funds. Overdraft may be a good instrument to raise funds for a short term and if used wisely, it can help / assist you tackle your short-term financing needs smartly.
Banks offer / provide overdraft facility to individuals / people against assets like property, securities & life insurance policies. The individuals need to pay interest on the amount depending on the period.
What is (overdraft)?
Overdraft facility is a credit line given to a people / individual against his assets. For i.e., you can mortgage your house with a bank and get a borrowing limit sanctioned against it.
If your house is worth Rs. 1 crore, reliant on your re-payment capacity and other factors like remaining life of the property, bank’s rules, bank may give you a limit of Rs. 50 lakh.
The money is not consumed to you immediately. It just works like an approved loan. As and when you want, you can keep retreating / withdrawing money from this overdraft account. You’ve to pay interest on the money borrowed for the time you’ve availed it.
You can keep borrowing and repaying your money as long as the bank is willing to offer such overdraft facility to you. The interest rate payable on such facilities against property usually ranges b/w (12 to 14%) per yr.
You can offer the bank assets such as your insurance policies, shares & bonds, bank fixed deposits. The interest rate does vary for each of these collaterals.
For i.e., you may end up paying around (12 to 14%) for an overdraft against property. Banks charge (1%) more than the rate payable on the fixed deposits for the overdraft against fixed deposits.
For i.e., if your fixed deposits are earning you (8%), an overdraft availed against them will make you pay at the rate of (9%) for the period you avail the credit. This credit facility is secured by an asset & the rate of interest payable is much cheaper as compared to spending on credit cards.
How to go about it?
The process is similar to taking any other loan. You can supply / offer your bank a host of collaterals, like your house, shares, insurance policies, bonds, fixed deposits & obtain such overdraft facility. But each one of these has their own up-sides and down-side.
For i.e., taking an overdraft against property though allows you a larger line of credit as compared to a fixed deposit in absolute terms, property evaluation will take some time. However, the bank will be much faster while sanctioning overdraft against fixed deposits.
Banks are more comfortable providing / offering an overdraft against fixed deposits or traditional life insurance policies. Typically, traditional life insurance policies do not offer / provide good returns. Taking an overdraft against them is a better way to putting them to productive use, he adds.
Banks consider surrender value of life insurance policies while offering overdraft. There are banks who selectively offer temporary overdraft facilities against salary of a people / individual. For i.e., if you have a salary of Rs. 1 lakh a month, there is a credit line of Rs. 50 thousand available to you, the salary credited is adjusted against the credit outstanding at the end of the month.
You’ve to additionally factor in the ‘haircut’ – the margin of safety – the bank will take. For i.e., the bank will be comfortable in approving limit up-to (50%) of the value of the property but in case of a fixed deposit, may offer up-to (70%) of the fixed deposit amount.
Depending upon the limit you want / need, you should select or choose the collateral. Along with the collateral, banks charge a small 1 time fee – (0.5 to 1%), subject to a cap of, say, Rs. 25 thousand. This is especially true when you are offering property as collateral as the bank has to conduct due diligence on the title and value of the property. Overdraft limits are approved for a yr., and the bank typically reviews them each yr.
Should you go for it?
Financial experts or consultants say, overdraft facility is meant for disciplined people / individuals. This is just because many people tend to misuse the funds. It is a credit line available with you & if you use it to fund speculative activities like short-term trading in stocks, commodities or currencies.
If you lose in such speculative adventures, you’ve to pay for it in addition to the interest rate accrued on the overdraft availed. And if you fail to pay on time, the bank could liquidate the asset.