Understanding Overdraft Limits: Definition and Calculation Guide

When a bank allows you to withdraw an amount that exceeds your account balance, these withdrawals are known as overdraft withdrawals. Overdraft accounts are the bank accounts that offer customers overdraft withdrawals. The bank’s overdraft limit refers to the amount of money that can be withdrawn in addition to the credit bank balance. Furthermore, if a customer exceeds their overdraft limit or misses a payment, the bank levies additional costs. You can borrow money from your bank’s current account if you pick the overdraft option instead of a personal loan. However, the amount of money you can withdraw has a limitation.

Overdraft Limit Withdrawals and Their Types:

The overdraft withdrawal facility limits the amount you can withdraw from the account. This amount depends on the customers, their bank relationships, and their transactional and repayment history. There are two types of overdraft withdrawals depending upon the nature of the collateral. 

1. Secured Overdraft: When you withdraw an overdraft against your saving or provide something as collateral to the bank, then that overdraft is known as the secured overdraft. The nature of your collateral determines the amount that you can withdraw from your account. 
2. Unsecured Overdraft: When you withdraw an overdraft without providing any collateral, that is known as an unsecured overdraft. Since the bank does not guarantee any overdraft, the withdrawal limit is determined by assessing your transactional history or relationship with the bank.

Advantages of the Overdraft Withdrawals

Following are the advantages of availing overdraft loan:

1. The Cushion of Financial Crunches:  You might get an overdraft loan when you don’t have enough money in your account. An overdraft provides you with the security of knowing you’ll always have a financial backup, ideal for temporary financial troubles, unexpected bills, or emergency needs.
2. Easy to Maintain CIBIL Score:  If a person takes out or repays loans regularly, their CIBIL score is more likely to fluctuate. If this happens regularly, you may have trouble obtaining credit cards or loans soon, which Overdraft Limit can resolve. You will only be given a single loan that you will be responsible for regularly if you choose this option. As a result, your score will improve as a result of this.
3. No EMI:  Unlike a mortgage loan, there are no set Equated Monthly Instalments. As a result, you do not pay a set sum each month. Instead, you have the flexibility of repaying or prepaying the loan in any amount you like. To avoid penalties, all you have to do is make the minimum payment each month.
4. Flexibility: An overdraft allows you to borrow as much money as you need while staying within the established limitations. In addition, you have the option to stretch out the payments as you see fit. Depending on your preferences, you can pay in days, weeks, or months.
5. Interest Rate: Even if you do not use the money, interest begins to accrue once you have taken out a Personal Loan. If you pay off the loan early, you’ll have to pay prepayment costs in addition to the principal and interest owed up to that point. You won’t have to pay interest on the money you haven’t withdrawn from your overdraft limit if you have an overdraft. With an overdraft, prepaying the amount is simple, and there are no additional fees.
6. Prepayment Charges: Prepayment costs must be paid when you prepay any loan amount or the EMIs that you have availed at a fixed interest rate. However, in the case of an overdraft loan, prepayment costs are waived even if you pay off your overdraft loan in full before the due date.

How Does Overdraft Work?

An applicant obtains the requested overdraft amount similarly to requesting the loan. However, banks hold the autonomy over the amount that you can withdraw at one point, depending upon the collateral. An applicant for a pre-approved overdraft facility can take cash from the bank anytime he wants, and the account will fall into overdraft. The bank will charge interest from the time you borrow until you repay the loan. 

An applicant can pay back the money to the creditor in whole or in part at any time. Money can be withdrawn from the account when the need arises until the overdraft limit is met. The bank has no security against the overdraft facility through the bank account. Borrowers who use their assets as security for an overdraft use secured collateral. In addition, the bank assesses interest rates on those collaterals.

Because the borrowed money can be credited in the borrower’s bank account at any moment, and the borrowed amount ledger might alter daily, interest on the overdraft amount is computed daily. Depositing money into your bank account lowers your outstanding balance, lowering your overdraft limit.

The lender or bank has the complete choice over whether or not to increase or lower the overdraft limit. You can go to your lender and seek an increase in your overdraft limit.

How is The Overdraft Limit Calculated?

The overdraft limit is determined by the transactional history of a person, business, or corporation. Financial stability, account balance, account age with bank, creditworthiness, connection with bank, debts or defaults, if any, and many other variables go into determining the overdraft limit. In most cases, a borrower can only utilize funds up to the sanctioned amount. He is not allowed to exceed the overdraft limit.

Conclusion:

When compared to personal loans, overdrafts are a better option. If you fear needing several personal loans, an overdraft account is a preferable alternative. On the other hand, you should consider an overdraft only if you need one loan with a more incredible principal amount and a more extended repayment period. It is advised to assess your needs before deciding on the overdraft facility carefully.

Business Loan or Overdraft – Which is Better?

What is the difference between Cash Credit and Overdraft?