The coronavirus pandemic has severely impacted the finances of many. In these tough times, people are considering credit facilities to overcome their liquidity shortage. While there are several options available in the market, one option that can also be mulled is ‘overdraft’.

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Overdraft is a credit facility linked to a bank account. In this, a user can use or withdraw money from a bank account even if there is no money left in the account.

In short, this product allows customers to overdraw on their bank account, says Sameer Aggarwal, Founder and CEO, RevFin—a digital lending FinTech startup.

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This feature is provided by almost every financial institution, including banks and NBFCs.

An overdraft facility can be sanctioned against house, fixed deposits and insurance policies as collateral. It is also possible to attain an overdraft facility through equity.

How does it work?

An overdraft facility, Aggarwal says, works a bit like a credit card wherein there is an overdraft limit set and a user can withdraw up to the limit over and above the balance in their account.

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“However, unlike a credit card, there is no interest-free period on overdrafts. Hence, interest and fees are charged on overdraft from the day customers use the limit,” he explains.

How can one repay it?

An overdraft can be repaid whenever the borrower has the money. One is not required to repay the amount like a loan.

They can repay whatever amount they want. However, if the lender demands a repayment, then they will have to fulfill that demand, according to Paisabazaar.

Aggarwal says that amount overdrawn must be repaid as soon as possible to avoid interest charges, which can be very high. It can also impact the credit score.

Is it right to use it?

Overdraft must be used with caution and only when absolutely necessary, say experts.

"If the need for credit is long term then loans are a much better option as interest rates are generally lower on loans. Also, a credit card is a better alternative to an overdraft as it comes with an interest-free period, which can extend to almost 50 days,” explains Aggarwal.

If absolutely necessary, it must be taken for a very short term.

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First Published:Aug 14, 2020 10:39 AM IST