When to use a bank overdraft account?

Published: September 25, 2020 at 9:33 am

An overdraft account is a type of credit facility offered by a bank in which one can overdraw funds, for example, write a cheque for Rs. one lakh when our account balance is zero. In this article, we discuss when it should be used.

Overdraft accounts can be created with fixed deposits (most common) or even against property or salary. In the case of FD, you can borrow an amount up to say 75% of the FD amount at an interest rate of 1% more than the FD. This borrowing can be done in batches and the interest payment will begin immediately.

This article was written in collaboration with a commissioned writer who is from the financial services industry. The self-references represent the author and views expressed here are that of the author and do not necessarily reflect the views of freefincal.  Other work from the same writer: Bank Perpetual Bonds: What you need to know before buying and What happens if my bank fails? All about Deposit insurance (DICGC) and Here is how NRIs can invest in Government of India Bonds (G-secs).

Disclaimer: Personal finance – being “very personal”, the utility of an Overdraft varies with the profession, lifecycle stage, net-worth etc.  A note for readers who are Businessmen, Investors, Traders: it may be a wise decision to use an overdraft account if you are confident of earning more than the interest that you pay for.  I have seen several successful businessmen put their entire working capital as a fixed deposit; take an overdraft against this fixed deposit and then run the operations through the overdraft account. On a personal note, I had followed the same principle of putting all my little capital in a fixed deposit, taking an overdraft against it and then using it towards monthly expenditure and card payments.

There are several use cases of an overdraft account depending on the profile and need of the individual. This article is largely for a common man in India. (salaried individual/small businessmen/professionals).

Types of overdraft

  1. Secured Overdraft is available against:
    • Fixed Deposit (except tax saver fixed deposits)
    • Shares
    • Mutual Funds
    • Gold
    • Insurance Policies
    • To existing Home Loan/Car Loan customers.
    • As a home loan variant as well – ‘SBI MaxGain’ – Ashal Juahari has done numerous posts on it.

Almost all banks today provide the option of availing an overdraft against fixed deposit through their net banking/mobile app.

  1. Un-Secured Overdraft:

There has been a surge in FinTech companies in India providing un-secured loans/overdraft. ‘Pay Later’ by tech giants like Amazon, Shopify, Flipkart is also a kind of overdraft loan. Tech companies view ‘financing’ as a must-have “feature” for the shopping ‘experience’.

 Unsecured overdraft comes at a higher cost.

Interest: Typically, the interest(spread) is approximately +1% to the FD interest rate. The interest can be negotiated while availing a Overdrafts of higher value like a crore and upwards.

Charges: Banks in India are generally pretty clean when it comes to Overdraft against fixed deposit Charges.  Administrative charges are approximately Rs.500/- for a PSU bank. There may be a nominal charge every month, in the event of non-utilization of the OD limit.

 Overdraft charges in News: Toronto-Dominion Bank “TD Bank”, has been fined $122 million by the BUREAU OF CONSUMER FINANCIAL PROTECTION, the USA for illegal overdraft practices. It was alleged that ‘no explicit-opt-in’ consent of the customers was obtained for allowing OD in their accounts. A study by ‘Center for Responsible Lending’ has shown that big banks combined have charged > $11 billion towards overdraft fees/non-sufficient fund fees from US consumers in 2019. Thankfully, in India, the system seems to be quite transparent as of now. (No wrongdoings has come out so far!)

Who should use an Overdraft Account?

  • If you get impatient when you have an outstanding debt.
  • If you pay your bills the moment they come to you.

Someone with the above traits would repay the OD as fast as s/he can.   Such individuals would ensure that their outstanding remains as low as possible.

When should you use an Overdraft Account?

  • Financial or Medical Emergency
  • Pandemics 🙁
  • In non-emergency cases: Use it when you expect the overdraft to return to credit balance (repaying the money) in near short team. You should be confident that you would be receiving money on ‘x’ date, but you need money today.
  • If you really need to borrow money and the Overdraft is turning out to be cheaper than other loans.

Who should not use an Overdraft Account? If you are impulsive by nature and you tend to easily make purchases in a jiffy.

When should you not use an Overdraft Account?

  • To bet on IPL, play in a casino.
  • To loan the money to some distant relative/acquaintances.
  • Consumption purposes: A ‘traditional Indian father’ mindset would advise against using it to buy gadgets, home appliances, travel
  • Definitely, DO NOT USE it for long term fund requirements.

Credit card v/s OD account?

  • A credit card has interest free period; interest on OD account starts on the same date.
  • A credit card has a fixed due date for repayment, OD doesn’t a ‘repayment’ date as such.

If you keep the above in mind, there would be times when a credit card is more suited and there would be times when an overdraft account is better suited.

 RBI on overdraft account for Business Loans: For businesses having Overdraft facilities (loans), RBI has asked banks to not to open current account of businesses who have availed OD Loan from other banks. RBI wants to bring in ‘discipline’ among the business community for routing of transactions through the loan account. The rationale is: Businesses avoided paying dues even if they had cash flows. This was possible as the receipts of the business were credited to a different bank account and not in the loan account.

In summary, there is nothing wrong with having an active overdraft account.  However, lack of credit discipline may lead the account to be utilized permanently i.e. it is in debit balance almost the entire year. Therefore use overdraft only if you are certain of profitable future cash flow from the amount you are overdrawing.

Do share if you found this useful

Did you know? We have more than 900+ videos on YouTube to explore! Join our YouTube Community!

Use our Robo-advisory Excel Template for a start-to-finish financial plan!

Join our courses in exclusive Facebook Groups!

  • 500+ members are now part of our new course, How to get people to pay for your skills! (watch 1st lecture for free). Learn how to get people to pay for your skills! Whether you are a professional or small business owner wanting more clients via online visibility or a salaried person wanting a side income or passive income, we will show how to achieve by showcasing your skills, building a community that trusts you and pays you!
  • 1822 members have signed for Goal-based portfolio management (watch 1st lecture for free). This is an online course to reduce fear, uncertainty and doubt while investing for a financial goal. Learn how to plan for your goals before and after retirement with confidence.

Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
We publish mutual fund screeners and momentum, low volatility stock screeners on a monthly basis
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association, IIST Alumni Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps