Fixed Deposits (FDs) are one of the most sought-after investment options for conservative investors who are looking to hedge risks by enjoying steady, assured returns. Most people know of FDs, but fewer are aware of a relatively beneficial feature that some bank FDs offer — the overdraft facility. An overdraft facility is in simple terms a credit facility. In this blog, we will explain what an overdraft facility is and how it works, so that you can make an informed decision when considering credit options to finance your emergency needs.
What is an Overdraft Facility on FD
An overdraft facility on an FD allows holders to withdraw money from their account even if they do not have adequate funds in a savings account matching the overdraft amount, with their fixed deposit as a guarantee. In simple words, this facility becomes a credit line against your FD. It is particularly advantageous when you need instant money and don’t wish to break the deposit, thus losing out on whatever interest has accumulated so far.
How an Overdraft Facility Works
The overdraft facility on an FD works in a straightforward manner. The bank allows you to overdraw money from your account up to a certain percentage of your FD’s value, typically ranging from 70% to 90%. The exact percentage depends on the bank’s policies and the terms of your FD. For instance, if you have an FD worth INR 1,00,000 and your bank offers a 90% overdraft facility, you can overdraw up to INR 90,000.
Interest is charged only on the amount you overdraw, not on the total overdraft limit. This interest rate is generally lower than the rate for personal loans or credit cards, making it a cost-effective solution for short-term financial needs.
Key Features of Overdraft Facility
Understanding the key features of the overdraft facility on FD is crucial for maximizing its benefits. Here are some aspects that make this facility an attractive financial tool:
- Flexibility: The facility offers flexibility in terms of repayment. You can repay the overdraft amount in parts or all at once, depending on your financial situation.
- Interest Calculation: Interest is calculated daily on the outstanding amount, which helps in keeping the interest costs in check.
- No Prepayment Charges: Most banks do not charge a penalty for prepaying the overdraft, which allows you to clear your dues as and when you have the funds.
- Convenience: Accessing the overdraft facility is relatively easy and hassle-free. It involves minimal paperwork and doesn’t require approval like a regular loan.
Advantages of an Overdraft Facility
Leveraging the overdraft facility can provide several advantages that make it a preferable choice over other borrowing options. Some of the key benefits include:
- Quick Access to Funds: One of the significant advantages is the quick access to funds without the need for lengthy loan approval processes.
- Cost-Effective: The interest rate on overdraft against FD in small finance banks is generally lower than personal loans and credit cards, making it a cheaper borrowing option.
- No Loss of Interest: Unlike prematurely withdrawing an FD, which can result in losing the interest benefits, the overdraft facility allows you to retain your interest earnings on the FD.
- Credit Score Impact: Timely repayment of the overdraft can positively impact your credit score, showcasing your ability to manage debt responsibly.
Drawbacks of Overdraft on FD
While the overdraft facility on FD provides numerous benefits, it’s essential to be aware of its potential drawbacks to avoid financial pitfalls. Here are some of the cons you should consider:
- Risk of Overborrowing: Easy access to funds can sometimes lead to overborrowing, which might result in financial stress if not managed properly.
- Interest Accumulation: While the interest rate is lower, the daily accrual of interest can add up, increasing the total repayment amount if not paid off quickly.
- Limited to FD Value: The overdraft amount is limited to the value of your FD. If you have a smaller FD, the overdraft facility may not provide sufficient funds for your needs.
Conclusion
An overdraft facility on FD is a handy financial tool that offers quick and flexible access to funds at a lower cost compared to other borrowing options. However, like all financial tools, it should be used judiciously, keeping in mind the potential drawbacks. Understanding how the overdraft facility works and its implications can help you make an informed decision and leverage your FD effectively during financial crunches.
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