Overdraft Limit

An overdraft limit is the maximum amount of money a bank allows an account holder to withdraw beyond their actual account balance. This facility is typically offered on current accounts and some savings accounts and is often used by businesses and individuals to manage cash flow gaps, cover emergency expenses, or handle short-term funding needs.

Key Aspects of an Overdraft Limit

1. How It Works:
   • When you have an overdraft facility, you can withdraw more than your available balance up to a specified limit.
   • This borrowed amount incurs interest, and the account holder is expected to repay it, along with any applicable fees.
   • The overdraft facility can be adjusted periodically by the bank based on your relationship with the bank and account activity.

2. Types of Overdrafts:
   • Secured Overdraft: Backed by collateral like fixed deposits, property, or investments. Secured overdrafts usually come with lower interest rates.
   • Unsecured Overdraft: Does not require any collateral but is generally offered to customers with a strong credit history. Unsecured overdrafts typically carry higher interest rates.

3. Interest and Fees:
   • Interest is charged only on the amount utilized, not on the entire limit, and is calculated on a daily basis.
   • Some banks may also charge an annual or monthly maintenance fee for keeping the overdraft facility active.
   • Interest rates on overdrafts are typically higher than on regular loans but lower than on credit cards.

4. Repayment Terms:
   • Overdrafts are usually repayable on demand or as per agreed-upon terms with the bank.
   • Some banks may require periodic payments, while others may allow you to repay as per your convenience, though interest accrues daily.

5. Benefits of Overdraft Limits:
   • Flexibility: Provides access to extra funds when needed, without having to apply for a loan each time.
   • Emergency Access: Helpful for managing unexpected expenses or cash flow gaps.
   • Pay Interest Only on Usage: Interest is only charged on the amount used, not on the entire limit.
   • Credit Score Impact: Unlike missed credit card payments, overdraft usage (if within limit and managed well) doesn’t negatively impact your credit score.

6. How Overdraft Limits are Determined:
   • Banks determine your overdraft limit based on factors like your income, account history, credit score, and the type of account you hold.
   • For businesses, overdraft limits might be based on the company’s average revenue, profit, and relationship with the bank.

Example of Overdraft Calculation

If you have an overdraft limit of ₹1,00,000 and withdraw ₹50,000, interest will only be charged on the ₹50,000 withdrawn. If your bank charges 12% per annum on overdrafts, your daily interest would be calculated as:

Daily Interest=₹50,000×12%/365

Overdraft Limit vs. Loan

While both allow you to borrow, an overdraft is more flexible for short-term cash needs without a fixed repayment schedule. Loans are typically for a set purpose, amount, and tenure, with fixed monthly payments.

Note: Overdrafts are beneficial for managing cash flow but should be used carefully due to high-interest costs, especially for unsecured overdrafts.