Using the overdraft facility for short-term funding



Financial urgency is not an unknown situation, and usually in such a situation, when we are in a monetary crisis, we immediately seek credit to meet our current needs. Credit can take any form, like bank loans or credit cards, but the interest rates associated with it are quite high. In addition, there are situations in which contingent funds are not sufficient to meet certain short-term financing needs.

So what is the solution then?

Ease of overdraft, few people know this ease of banks against their assets to finance short-term needs. It is quick to get approval from banks and cheaper than other loan offers.

Here are the procedures and benefits of the overdraft facility and how you should use it to meet your financial emergency.

Significance of ease of overdraft:

The overdraft facility is a loan granted to an individual against his assets as collateral with the banks. As collateral, you can offer banks the following assets: house, insurance policies, bank term deposits, stocks and bonds, etc. However, the interest rates charged and the overdrafts sanctioned by the banks vary on each of the guarantees.

What do we really mean by guarantees?

Use your home as collateral: the bank conducts an appraisal and survey of the property, then sanctions an overdraft limit of up to 50% to 60% depending on the value of the property, your credit history and your repayment capacity. Suppose, according to the appraisal report, that the current price of your house is Rs 1.5 crore, and then you are eligible for an overdraft of up to Rs 90 lakhs. However, this amount will not be paid immediately. It works like an approved loan and you can continue to withdraw the amount from that overdrawn account when needed. You are eligible to pay an interest rate from the time that overdraft is used and the amount withdrawn. Interest rates for loans against property vary between 12% and 14% pa

Using bank term deposits as collateral: On term deposits you can get a higher percentage of the sanctioned amount (around 70%) as an overdraft facility compared to the house as collateral. Also, the interest rates charged by banks are lower than the house collateral. While taking an overdraft against term deposits, banks charge one percent more than the interest rate payable on the term deposit system. Consider that your fixed deposit generates interest income of 9% per year, then you will pay 10% interest charge per year for the period in which you benefit from the overdraft.

Using your insurance policy as collateral: On the life insurance policy, you qualify for a higher percentage of the sanctioned amount as overdraft, compared to the home as collateral. The overdraft amount is calculated on the cash surrender value of the life insurance policy.

Use of equity as collateral: Stock prices are volatile relative to the market and the economy of the country. Thus, it is considered a risky asset class for overdraft. Banks regard equity as collateral for overdrafts, but the sanctioned percentage of the current market price of shares is lower.

Overdraft Against Your Salary: Banks offer a temporary overdraft facility against your monthly salary. Think of your monthly salary as Rs 2 lakhs per month, then you will be entitled to an overdraft of up to Rs 1 lakh against the salary.

How do I apply for an overdraft facility?

The process for applying for an overdraft facility is similar to that for any other bank loan. You will offer an asset as collateral to the banks and get an overdraft facility. The term is longer for the overdraft penalty in case the collateral is your home, as it requires a property appraisal and bank / official investigation. Whereas, getting an overdraft amount sanctioned against term deposits or a life insurance policy is quick.

Banks charge processing fees of 0.5% to 1% with a ceiling of Rs 25,000 as well as guarantees. This overdraft facility is approved for one year and the bank reviews the value of the collateral assets every year.

Word of caution:

There are cases where people tend to take an overdraft facility against collateral to invest money in the stock or commodity markets. It is strictly not recommended to play with the amount of the overdraft in such volatile markets.

Go for the overdraft facility if you need short-term emergency financing. Pay the interest on your overdraft regularly and repay the overdraft amount on time to the bank. If you do not repay the amount, the bank will liquidate the asset against which you have overdrafted.

Source: InvestmentYogi is one of the leading personal finance websites in India

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