Overdraft Against Salary: A Comprehensive Guide to Making the Right Choice

While these circumstances are quite common, there may be instances when unexpected financial obligations arise in certain months. These unforeseen expenses could include things like car repairs, close relatives' weddings, tuition fees for children, medical emergencies, and whatnot!

During such financial crises, when individuals need instant funds, they often consider availing of a Personal Loan or swiping a credit card. However, with many leading banks offering overdraft facilities against salary accounts, it could be perplexing to decide whether to opt for an Overdraft Against Salary or explore alternative borrowing options.

This article aims to clarify all aspects of this borrowing facility, including its meaning, how it works, advantages and disadvantages, the process for availing this loan, a comparison between a Personal Loan and an Overdraft Against Salary, and whether choosing an overdraft facility against your salary is the right choice for you.

What Is an Overdraft Against a Salary?

An Overdraft Against Salary, also known as Salary Overdraft, is an overdraft facility provided by banks to individuals holding salary accounts. It allows salaried account holders to make withdrawals or write checks even when their account does not have the required balance or is at zero. The Overdraft Against Salary represents a form of short-term Personal Loan exclusively available to individuals who are employed and maintain salary accounts with the lending bank.

How Does an Overdraft Against a Salary Facility Work?

Here's how the Salary Overdraft facility typically works:

1. Eligibility:

To qualify for an Overdraft Against Salary, you typically need to be a salaried individual who maintains a salary account with the lending bank. The bank assesses your creditworthiness and approves an overdraft limit based on your salary and other financial factors. It is important to understand that not all salary accounts come with the overdraft facility, and it solely depends on the bank's discretion.

2. Overdraft Limit:

The bank sets a predetermined overdraft limit for you. This limit represents the maximum amount you can utilise (overdraw) from your salary account. It is not the same as your account balance; it's an additional borrowing capacity.

Many leading banks offer pre-approved overdraft limits to certain salary account holders. However, the pre-approved overdraft limit can vary from one borrower to another, and the terms related to it differ from one bank to another.

If you have a pre-approved limit, you can get instant access to cash, but if you do not have the pre-approved limit, you will be required to apply for the Salary Overdraft facility with the bank. Upon your application approval, the bank will set a predetermined overdraft limit for you based on your profile.

3. Activation:

When you need to access funds beyond your account balance, you can activate the overdraft. This is usually done by withdrawing money or writing checks, and the overdraft facility kicks in automatically.

4. Interest on Utilised Amount:

Unlike Personal Loans or any other traditional loans, where the borrower is charged the interest for the entire amount borrowed, irrespective of the amount of loan utilised, the Salary Overdraft facility charges interest only to the amount of funds used. This interest is calculated daily and billed at the end of the month. If you fail to adhere to the set repayment schedule, the interest amount will be added to the principal balance at the end of the month, and the interest will subsequently be calculated based on this adjusted new principal amount.

5. Repayment:

Repayment of the overdraft is not structured like a conventional loan with fixed EMIs. You can repay any amount at your convenience whenever you have the funds. However, if the lender requests for repayment, you must fulfil that demand.

While overdrafts against salary do not have a minimum monthly repayment requirement, the outstanding amount should remain within the overdraft limit. It's essential not to delay the repayment for an extended period, as this delay can negatively impact your credit score.

Many leading banks nowadays offer an auto sweep-in facility that automatically repays your dues as and when a sufficient balance is available in your salary account.

6. No Prepayment Charges:

Typically, when you want to repay a loan early, there are prepayment charges. However, this is not the case with an overdraft facility. When you repay the amount borrowed through an overdraft, you are not subjected to prepayment charges.

7. Account Management:

You need to monitor your account to ensure that you stay within your overdraft limit and manage your finances effectively. Going beyond your overdraft limit may result in penalties or account closure.

8. Renewal:

Overdrafts are often offered as a revolving credit facility. When you repay the borrowed amount, your available credit is restored, and you can continue to use the overdraft as needed. However, depending on your financial standing, the bank may periodically review and renew your overdraft facility.

9. Security:

Overdrafts Against Salary are typically unsecured, meaning that you don't need to provide collateral or security to access this credit line. However, the bank's decision may vary based on your creditworthiness and the bank's policies.

What Are the Advantages And Disadvantages of the Overdraft Against Salary Facility?

Advantages of Overdraft Against Salary:

• Offers quick access to funds when needed

• A complete digital process with most banks

• No obligation for fixed monthly repayments

• Interest is charged only on the borrowed amount

• No fees for early repayment

• Activates automatically when the account balance is insufficient

• Many banks provide auto sweep-in facilities to avoid exceeding the limit

Disadvantages of Overdraft Against Salary:

• Interest rates can be higher than other loan options

• Potential to accumulate excessive debt if not managed responsibly

• Defaulting can negatively impact your credit score

• Only available to salaried individuals with good credit

• Banks charge high penalties for exceeding the limit

What Is the Difference Between a Personal Loan And an Overdraft Against Salary?

Here's a comparison of Salary Overdraft vs. Personal Loan:

1. The Type of Loan:

A Personal Loan is a fixed sum borrowed from a bank for a predetermined period and must be repaid in regular monthly instalments. It falls under the category of unsecured loans and is typically sought for immediate financial requirements but allows for longer repayment durations.

On the other hand, a Salary Overdraft is a credit facility extended to an individual or entity, allowing withdrawals that exceed the current account balance but within a specified credit limit. It serves as a credit facility with short-term repayment terms.

2. Interest Calculation:

Personal Loan interest rates are computed monthly and applied to the entire loan amount.

Overdraft interest rates are calculated daily and levied on the overdrawn amount; no interest is incurred if no overdrawn amount exists.

However, it is worth noting that overdraft interest rates are usually higher compared to Personal Loans.

3. Disbursement:

Obtaining a Personal Loan involves eligibility checks, document submission, vetting, verification, and approval, which can take several hours to a few days unless you have a pre-approved Personal Loan offer.

In contrast, Salary Overdraft funds become available within hours or may take up to a couple of days, even if you do not have a pre-approved overdraft limit.

4. Repayment of the Loan:

Personal Loan repayments are made through convenient monthly EMIs. You can calculate the EMI amount with the help of a Personal Loan EMI Calculator before opting for a loan.

Conversely, funds taken from an overdraft facility must be repaid through deposits into the account. As discussed earlier, there are no fixed EMIs in this case.

5. Loan Tenure:

Personal Loans typically come with repayment tenures ranging from 1 year to 5 years. If you want to repay the loan earlier than your loan tenure, you usually will have to pay prepayment charges.

In contrast, Salary Overdraft facilities lack fixed repayment tenures and don't entail extra fees like prepayment.

Should You Opt for an Overdraft Against Your Salary?

Banks typically offer loans for various purposes, and an Overdraft Against Salary is often considered one of the most convenient options. While it's undoubtedly a handy way to access emergency funds for the short term, it is necessary to understand the workings of the Salary Overdraft and its pros and cons.

Essentially, an Overdraft Against Salary functions much like a credit card. Depending on the terms associated with your account, you can withdraw a specific amount over and above your salary account balance when the need arises.

Typically, banks provide a credit line ranging from one to three times your net monthly salary. Access to the overdraft facility is typically extended to select salary account holders based on eligibility and credit history.

Additionally, if you decide to continue using the credit beyond one year, there might be processing and annual fees.

Take note that an Overdraft Against Salary can be costly. The interest rates tend to be relatively high, ranging from 11% to 35% per year, depending on the bank. This form of credit can become quite expensive when combined with processing fees and potential penalties for missed payments.

So, if you have a short-term fund requirement and know how much exactly you need, it makes sense to opt for a Personal Loan rather than a Salary Overdraft. This will save your interest amount, and you can comfortably pay the EMIs over the loan tenure.

Furthermore, in case you do not specifically need cash and it is possible to swipe your credit card to fulfil your financial requirement, you might find better value with a credit card, which offers perks like exclusive offers and reward points and more at a significantly lower cost. However, you need to be sure that you can repay the funds before the next bill due date.

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KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.

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This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.