What Is OD Facility Given by Bank?
August 17, 2023
Meet Mr Anshul Mehta, an IT service exporter, currently facing a cash crunch due to delayed payments from his international clients. These delayed payments have affected his liquidity, making it challenging for him to pay salaries to his staff and fulfil his tax obligations on time. In this difficult situation, Mr Mehta uses his bank's overdraft facility to address his short-term capital requirements effectively.
The bank overdraft facility is a valuable tool for Mr Mehta to manage his short-term capital requirements during this period of cash crunch. It allows him to bridge the gap between delayed payments and essential financial obligations without disrupting his business operations.
In times of financial difficulty, a bank overdraft facility can be a lifesaver for businesses like Mr Mehta's. It provides a flexible and approved line of credit to address short-term capital requirements, allowing entrepreneurs to manage their financial obligations efficiently. By judiciously utilising such facilities, businesses can navigate challenging times and ensure continuity and growth.
Let’s learn how.
How Does the OD Facility Work?
The Overdraft Facility allows you to withdraw money over the amount available in your bank account within the specified limit. This means you can use an overdraft facility even if your account has zero balance. It is a short-term credit agreement to help you meet more immediate or direct capital requirements.
The scope of the overdraft facility depends on the credit limit pre-sanctioned by the bank based on its relationship with the customer. You can withdraw small amounts of money or the entire credit limit together. An overdraft facility differs from a business loan as you are charged interest only on the amount you withdraw, not the total sanctioned credit limit.
Overdraft interest rates may vary from one bank to another. Banks also levy OD charges for non-maintenance of the account. While there are no prepayment penalties, banks may charge you increased interest rates if you default on your payments.
The repayment duration is 12 months, compared to a business loan, which can extend to 10 years. Additionally, there is no system of instalment in overdraft. You can repay in a lump sum amount or instalments, unlike loans with regular EMIs to be paid over a fixed tenure.
Mostly all financial institutions in India provide an overdraft facility to their customers. However, the amount and rate of interest depends upon several factors, such as–
- The borrower’s profile
- Credit score rating and financial history
- Relationship with the bank
- Repayment capacity
Types of OD Facilities
An overdraft facility can be secured or unsecured.
A secured overdraft can help you access additional funds if you have specific assets, such as property, fixed deposit, insurance policies, and equity investments, to offer as collateral against the overdraft. Unsecured overdrafts allow you to access your bank's sanctioned line of credit without collateral.
The interest rates on unsecured overdraft facilities are more than secured overdrafts.
Eligibility and Application Process
1. Eligibility Criteria for OD Facility
- Age: Any person between the age of 21 and 65 years
- Bank account: Applicant must have an account with an existing bank
- Minimum Income threshold: varies from bank to bank
- Credit score: A good credit score is an added advantage
2. Required Documents
- Duly filled-in application form with a passport-size photograph
- Identity proof such as Passport, voter ID card, PAN card, License, Aadhar card
- Address proof such as Passport, Driving License, Voter ID card, and Utility Bills
- Age proof such as a Class X certificate, Passport
- Last 12 months’ bank statement
- Any other document asked by the lender or bank
3. Application Process
If the bank does not offer a pre-approved overdraft limit, you can apply for it with the bank by filling out the designated form and furnishing the required documents. You can initiate the application process via internet or mobile banking or by visiting your bank branch.
Advantages of an OD Facility
- Financial Flexibility and Convenience: An overdraft facility is a flexible way of accessing short-term credit to meet your immediate business needs. It is further convenient as you don’t need to submit tedious documentation and follow the approval processes in a business loan. The rejection ratio for loans is also higher, while the overdraft facility is readily available with most bank accounts.
- Quick Access to Funds: With an OD facility, you avoid the hassles of procuring a business loan which can take weeks to get sanctioned and credited to your account. You can avail of the OD facility at any time if you have a bank account with the respective bank.
- Cost-Effective Borrowing Option: The interest rate charged on the overdraft facility is lower than that on a business loan. Additionally, there are no prepayment penalties involved. The interest gets charged only on the amount you withdraw from your bank account, making ODs a cost-effective option to secure quick credit.
- Improving Cash Flow Management: An overdraft facility can provide immediate liquidity to improve overall cash flow management in daily business operations.
Tips for Using an OD Facility Responsibly
- Understanding the Purpose of the OD Facility: An overdraft facility allows businesses and individuals to meet urgent credit needs. It is a form of a loan you need to pay with interest. You must use the OD facility only when necessary and comply with the repayments in time.
- Monitoring and Managing the Credit Limit: Banks allow you to increase or decrease the credit limit on your overdraft facility. Keep a strict eye on your credit needs and set a limit accordingly.
- Repayment Strategies: While banks don’t have an instalment system for OD repayment, you still need to repay within a fixed tenure. The interest rates are applicable daily. Therefore, the sooner you finish your OD repayments, the more you save on interest.
- Avoiding Over Utilisation: Withdraw only the required funds from your OD limit to save on interest expenses and the unnecessary hassles for repayment. Prevent clauses where banks penalise underutilisation.
Borrowing through an overdraft is similar to borrowing a loan from a bank without the formalities and paperwork. Bank accounts may come with pre-entitled credit limits, or you can avail of the facility by applying with your bank or lender.
An overdraft facility provides businesses with immediate liquidity and cash flow management to meet short-term expenses cost-effectively. However, you should use ODs responsibly to ensure you remain in good financial standing with an appropriate credit rating.
Frequently Asked Questions about OD Facilities
1. When is a loan better than an OD facility?
A loan is better than an overdraft when you require an extensive credit amount over a longer period. Often when businesses want to finance long-term business needs such as buying land or updating technology, they require huge funds. In that case, business loans are a better choice than ODs.
2. Can I use the OD Facility for personal expenses?
You can use an overdraft facility to meet your expenses if you have a savings or salaried account. The bank will sanction the OD limit based on your account.
3. What happens if I cannot repay the Overdraft?
If you cannot pay your OD dues, banks report the credit bureaus, negatively impacting your credit ratings. It may be further challenging to get credit as banks put you in the high-risk borrower bracket. It can also result in increased interest rates on future loans and credits.
4. How is the interest calculated on an OD Facility?
Banks calculate the interest on your OD Facility by the average daily balance method on the amount you withdraw from your account.
5. Can I increase the limit of my OD Facility?
You can apply with your lender or bank to increase or decrease your OD limit using the internet or mobile banking or by directly visiting your bank branch.