An overdraft loan is a facility that allows the withdrawal of money even if you don’t have sufficient funds in your account. It is an extension of credit from a bank granted when an account reaches zero.
According to the reports of the Consumer Financial Protection Bureau, overdraft revenue for the fourth quarter of 2022 has decreased by 48% compared to before the pandemic. This suggests an annual reduction of over $5.5 billion going forward.
Understanding Dropline Overdraft
Drop-line overdraft grants customers to overdraw from their current account up to a limit as agreed upon by the banker. It is an efficient form of borrowing, as you need to pay interest only for the capital withdrawn.
For example, a business might get a ₹10 lakh limit, which is reduced by ₹50,000 each quarter. If after 6 months the limit drops to ₹9 lakh, the borrower must adjust their usage accordingly.
Features of Drop Line Overdraft
It can come in both forms of loan, i.e., secured loan and unsecured loan.
| 1 | No requirement for collateral for an unsecured drop-line overdraft |
| 2 | Drop-line overdraft is a hybrid of both term loan facilities. |
| 3 | The sanction limit reduced the withdrawal limit every month. |
| 4 | The facility is available for the current account. Therefore, the bank credits only the amount to the available account. |
| 5 | Interest is charged on the amount withdrawn each month. |
| 6 | Highly beneficial for manufacturers, retailers, traders, and service providers. |
| 7 | No yearly renewal charges levied |
Special Considerations
There are various special considerations while availing of an overdraft facility. The bank uses its funds to cover your overdraft. It also links the overdraft to a credit card. If the bank uses its funds to cover an overdraft, it won’t affect your credit score.
You may increase debt to the point it affects your credit score when a credit card is used for overdraft protection. However, this won’t show up as a problem with overdrafts on your checking accounts.
If you fail to pay your overdrafts back in time, the bank can turn over your account to a collection agency. This affects your credit score and gets reported to the three main credit agencies. These are Equifax, Experian, and TransUnion. It depends on how the account is reported to the agencies. This will prove if it shows up as a problem with an overdraft on a checking account.
Understanding Overdraft Fee
An overdraft loan provided by a bank allows a customer to pay for bills and other expenses. It is usually available when the account potentially reaches zero.
For a fee, the bank offers a loan to the client in an unexpected charge or insufficient account balance. Generally, these accounts will charge a one-time fund fee and interest on the outstanding balance.
How Does Overdraft Protection Work?
Suppose a client’s checking account enters a negative balance. Therefore, they will be able to access a predetermined loan provided by the bank and be charged a fee. For most scenarios, overdraft protection is used to prevent a check from bouncing. In addition, an overdraft facility prevents a non-sufficient fund fee.
The benefit involves offering coverage when an account unexpectedly has insufficient funds. It saves from the embarrassment and “returned check” charges from merchants or creditors. However, it is also crucial to weigh the costs.
Types of Overdrafts
There are various kinds of overdraft facilities. A secured overdraft facility allows you to pledge your assets. If you fail to repay, the bank can sell off your assets to recover whatever they can. Five of the overdraft facilities are mentioned below:
- Overdraft against Property
- Overdraft against Fixed Deposits
- Overdraft against Insurance Policy
- Overdraft against Equity
- Overdraft against Salary
Conclusion
To sum it up, an overdraft occurs when an account lacks the funds to cover a withdrawal. However, the bank allows the transaction to go through anyway. It assists you to continue paying bills even when there is insufficient capital in your account. Most banks impose additional fees or penalties for overdrawn accounts. You should try your best to avoid such penalties.
