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Financial emergency is not an unheard situation, and usually in such a situation when we are in monetary crisis we immediately look around for some credit to meet our present needs. Credit can be of any form like bank loans or credit cards, but rates of interest associated with them are quite high. Also, there are situations in which contingent funds are not enough to fulfil some short term financing needs.
So, what is the solution then?
Overdraft facility, not many people are aware of this facility from banks against their assets to finance short term needs. It's quick to get approval from banks and cheaper compared to other loan offers.
Here are the procedures and benefits of overdraft facility and how you should use it to meet your financial emergency.
Meaning of Overdraft facility:
Overdraft facility is a credit given to an individual against his or her assets as collateral with banks. As collateral, you can offer following assets to banks: house, insurance policies, bank fixed deposits, shares and bonds, etc. However, interest rates charged and overdraft sanctioned by banks vary on each of the collateral.
What do we really mean by collaterals?
Using your house as a collateral: Bank does a valuation and survey of the property, then sanction an overdraft limit of up to 50% to 60% considering value of the property, your credit history and repayment capacity. Assume, as per valuation report, the current price of your home is Rs 1.5 crore, and then you are eligible for overdraft up to Rs 90 lakhs. However, this amount will not be disbursed immediately. It works like an approved loan and you are eligible to keep withdrawing amount from this overdraft account when required. You are eligible to pay interest rate from the time this overdraft is availed and amount withdrawn. The rates of interest for loans against property range between 12% & 14% p.a.
Using bank's fixed deposits as collateral: On fixed deposits, you are eligible to get higher percent of amount sanctioned (~70%) as overdraft facility compared to home as collateral. Also, interest rates charged by banks are lower compared to house as collateral. While taking overdraft against fixed deposits, banks charge one percent more than the interest rate payable on fixed deposit scheme. Consider, your fixed deposit is earning 9% interest income p.a. then you will be paying out 10% interest cost p.a. for the period you avail the overdraft.
Using your insurance policy as collateral: On life insurance policy, you are eligible to get higher percent of amount sanctioned as overdraft, compared to house as collateral. The amount for overdraft is calculated on surrender value of life insurance policy.
Using equity as collateral: Stock prices are volatile to market and economy of the country. So, it's considered as a risky asset class for overdraft. Banks consider equity as collateral for overdraft, but percent sanctioned against current market price of stocks is lower.
Overdraft against your salary: Banks offer temporary overdraft facility against your monthly salary. Consider your monthly salary as Rs 2 lakhs per month, then you will be eligible for overdraft up to Rs 1 lakh against the salary.
What is the process to apply for overdraft facility?
The process to apply for overdraft facility is similar to taking any other loan from banks. You will offer an asset as collateral to banks and obtain overdraft facility. The duration is longer for sanction of overdraft in case collateral is your home since it requires property valuation and survey from bank / government officer. Whereas, getting an overdraft amount sanctioned against fixed deposits or life insurance policy is quick.
Banks charge a processing fee of 0.5% to 1% with a cap of Rs 25,000 along with collateral. This overdraft facility is approved for one year and the bank reviews value of assets as collateral every year.
Word of Caution:
There are cases when people tend to take overdraft facility against collaterals to invest money in stock or commodity markets. It's strictly not recommended to play with overdraft amount in such volatile markets.
Opt for overdraft facility if you require finance for short term in emergency situation. Pay the interest regularly on your overdraft and repay the overdraft amount on time to the bank. In case you fail to repay the amount, the bank will liquidate the asset against which you took an overdraft.
Source: InvestmentYogi is one of leading personal finance websites in India
