Keep overdraft use limited to urgent needs, avoid rolling over dues

Availing of this facility without a clear repayment plan can lead to financial stress and higher borrowing costs over time, experts warn

If you have received many SMS messages recently pushing overdraft (OD) facilities, that is no coincidence. Lenders are actively marketing this loan product, especially through pre-approved, instant, app-based offerings.

 

“ODs are increasingly being positioned as flexible liquidity tools, with instant access and seamless integration into salary accounts, deposits, and business cash flows,” says Adhil Shetty, chief executive officer (CEO), BankBazaar.com.

 

How it works

 

An OD facility is a pre-approved credit line linked to a bank account, which allows customers to withdraw more than the balance available. Lenders charge interest only on the amount the customer uses. The link to a current or savings account allows smooth withdrawals and repayments.

 

ODs can be secured or unsecured. “Secured ODs, especially against fixed deposits (FDs), are the most widely used in practice because they carry lower cost and risk,” says Shetty.

 

In a secured OD, lenders typically offer 80–90 per cent of the underlying asset value as the limit. “In unsecured cases, limits are determined by income, credit profile, and account behaviour, such as regular inflows,” says Shetty.

 

Interest rates and other costs

 

Interest rates are lower for secured ODs. ODs against FDs are usually offered at one–two percentage points above the FD rate. “Unsecured ODs can range between 10 per cent and 24 per cent, depending on the borrower’s risk profile,” says Shetty.

 

Lenders decide the interest rate based on several factors, including the borrower’s credit profile, nature of the collateral, and so on. “Interest on the utilised amount is charged on a daily reducing balance,” says Shetty.

 

Repayment timelines and delay penalties

 

ODs are revolving credit facilities that lenders typically review every year. Borrowers must pay interest monthly on the amount used. Delays can attract penal interest. Lenders may impose penal charges of around 2–3 per cent if the borrower fails to pay interest or withdraws more than the sanctioned limit.

 

“RBI guidelines state that penal charges cannot be added to the principal amount to compute further interest and must be recognised separately,” says Manish Bansal, managing director, Surya Loan, which provides online loans to both individuals and businesses for short-term needs.

 

Sustained irregularity in repayment may affect credit scores or trigger recovery action, including liquidation of collateral in secured cases.

 

Pros and cons

 

ODs offer flexibility. Customers pay interest only on the amount used. “This makes it a cost-efficient option for managing short-term cash needs without committing to fixed EMIs,” says Bansal.

 

Pre-approved formats provide quick access to funds. “The secured variants are relatively economical,” says Shetty.

 

On the flip side, the unsecured variants can prove expensive. “Interest rates for unsecured facilities may be high, so prolonged usage can increase overall borrowing costs,” says Bansal.

 

Irregular servicing can lead to penal charges and affect the borrower’s credit score. “In case of secured OD, there is a risk of losing the underlying asset,” says Shetty. There is also the risk of over-utilisation if the facility is not handled with discipline.

 

Who should use an OD?

 

An OD facility works best as a short-term liquidity tool. “It is ideal for those facing temporary cash-flow mismatches,” says Santosh Agarwal, CEO, Paisabazaar.

 

Salaried individuals can use ODs to bridge gaps before their salary gets credited. “For salaried individuals, it suits short-term needs like medical expenses, school fees, travel, or gaps before bonuses,” says Jyoti Prakash Gadia, managing director, Resurgent India.

 

Self-employed professionals and small business owners can use ODs to manage delayed receivables or working capital needs.

 

Who should avoid it?

 

Borrowers with large or long-term expenses should avoid ODs because of the costs involved. “ODs typically have higher rates than personal loans, so only those with strong near-term cash inflows should opt for them to avoid high interest costs,” says Agarwal.

 

It is unsuitable for those with irregular repayment capacity, weak financial planning, or a tendency to treat the limit as surplus money. “An OD should not be used to fund lifestyle spending, speculative investments, or recurring monthly deficits,” says Gadia.

 

He adds that an OD can worsen repayments and increase the risk of default if the borrower is already burdened with card dues or multiple equated monthly instalments (EMIs).

 

OD vs other options

 

Borrowers should choose between a personal loan and an OD facility after assessing the purpose, tenure, and cost. “If the amount and tenure are clear, a personal loan is better as fixed EMIs enforce discipline,” says Gadia.

 

Experts say a credit card rollover should be the last option. “Credit cards are for convenience and carry high interest. An OD or loan against an FD is safer, quicker, and cheaper if an FD exists,” says Gadia.

 

Charges, terms, and clauses to check

 

Borrowers should look beyond the headline rate and check the effective annual cost. “Focus on the overall cost structure of the OD facility,” says Agarwal.

 

Check fees such as processing charges and penalty interest on overdue amounts. “These charges can raise costs, especially with intermittent or long use,” says Agarwal. She adds that borrowers should understand the lien terms and the implications of a default in secured ODs.

 

Borrowers should also check minimum utilisation and review clauses, as these can affect pricing and continuity. “Carefully examine processing fees, stamp duty, annual review charges, penal interest on due amounts, over-limit charges, electronic clearing service (ECS) return charges, and foreclosure or closure terms,” says Gadia.

 

Borrowers should understand a key clause: whether the OD is repayable on demand, which allows lenders to recall it if the borrower breaches the terms. “Borrowers should also read clauses related to cross-default with other facilities, renewal conditions, and reporting to credit bureaus,” says Gadia.

 

For ODs against FDs, borrowers should understand the lien, withdrawal limits, and what happens at maturity. Gadia adds that borrowers should review lenders’ rights carefully before signing floating-rate clauses.

 

Mistakes to avoid

 

The biggest mistake is to treat the limit as income. “Keep utilisation limited to urgent needs and link borrowing to clear repayment inflows,” says Gadia.

 

Borrowers should not use it as a permanent source of funds. “Borrowers often roll it over and pay only interest, turning a flexible facility into a costly habit,” says Agarwal.

 

They should have a repayment timeline and a backup plan for delays. “An OD without a pre-decided exit plan can become revolving stress rather than short-term support,” says Gadia.

 

 

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The writer is a Mumbai-based independent journalist