Overdraft
An overdraft is a credit facility linked to a bank account that allows the account holder to withdraw or use funds beyond their available balance up to a pre-approved limit, with interest charged only on the amount utilised and for the duration of use.
The overdraft facility was one of the oldest forms of credit offered by banks and remained highly relevant for individuals and small business owners who faced irregular cash flows. Unlike a term loan where the full amount was disbursed upfront and EMIs began immediately, an overdraft provided a revolving credit line: the borrower drew only what was needed, repaid it when funds were available, and interest accrued only on the outstanding utilised amount.
For individuals, overdraft facilities were often linked to salary accounts, savings accounts, or fixed deposits. A salary overdraft allowed a salaried employee to draw funds against their upcoming salary, with the facility automatically squared off when the salary credit arrived. A fixed deposit-backed overdraft allowed a depositor to borrow up to 85–90% of the FD value at an interest rate marginally higher (typically 1–2%) than the FD's earning rate, avoiding the penalty of premature FD closure while meeting short-term cash needs.
Overdraft facilities against property, investments, or business current accounts operated at larger limits and were subject to more formal sanctioning processes. The interest rate varied by the nature of collateral, the borrower's credit profile, and the lender's pricing policy. Most personal overdraft facilities carried rates between 8–15%, making them cheaper than personal loans for short-term needs, particularly since interest only accrued on amounts drawn.
The revolving nature of an overdraft was both its greatest strength and its greatest risk. Because there was no fixed repayment schedule, undisciplined borrowers could find themselves permanently utilising the full overdraft limit without making meaningful repayments, effectively paying interest indefinitely without reducing the principal. Banks managed this risk through annual reviews of the facility, which could result in a reduced limit or closure if the account showed insufficient repayment activity.
For personal finance management, the most prudent use of an overdraft was as a bridge for predictable short-term shortfalls — a known payment due before a salary credit arrived, or funds needed for a short investment window — rather than as a source of ongoing spending supplementation. Like all credit, its utility depended entirely on the borrower's discipline and understanding of the interest cost implications.