Every business people struggles at one point in moving forward in their business is due to financial crises. Financing is required for their daily expenses and meeting daily business requirements. Although short term business loans are available, businessmen face hassles to get loans at the desired time. These business loans cannot be availed as a stand-by option, in times of need. Here comes overdraft - a boon to business people.
What is Overdraft?
Bank Overdraft is a credit facility given to an individual against his or her assets as collateral with banks. Overdraft allows you to draw against your own account, a fixed amount beyond the available bank balance. As a collateral, one can offer house, insurance policies, bank fixed deposits, securities etc to banks. Interest rates on overdraft sanctioned by banks vary from customer to customer. The interest is charged according to the amount drawn from the account. This is a great thing for business people to get rid off financial bounces of their business. It is mainly used for smooth cash flow in the business transaction and also to meet day to day short term business expenses like purchasing stocks, raw materials and all general business expenses.
Difference between Overdraft and Business loan
Overdraft is very flexible source of raising capital for short term financial crises of variable amount upto a certain limit. Business loan is also a source of raising the capital of the business of fixed amount over a set of period with regular repayments.
The Benefits of an Overdraft facility:
- An overdraft provides you with cash for unplanned expenses.
- It provides the comfort to access extra cash for emergencies.
- It is a revolving account, used to manage day-day expenses and income.
- A Customer can use as much of agreed overdraft limit. The total limit is always available to them for use, as and when they repay it partially.
- In specific cases of overdraft against fixed deposits, Banks charge one percent more than the rate payable on the fixed deposits .
- Once you have an overdraft, you can conveniently increase or decrease your limit.
- This credit facility is secured by an asset and the rate of interest payable is much cheaper as compared to spending on credit cards.
Types of Overdraft
Overdraft can be given under two different types namely,
Secured Overdraft – Overdraft is set upto a certain limit against a security or collateral. The security can be residential or commercial property, land or industrial properties. Overdrafts can also be granted against fixed deposits, Insurance policies, Salary accounts, or Shares. Interest is lesser for a secured overdraft.
Advantages of cash credit
- Fixed Deposits as Collateral: On fixed deposits, businesses are eligible upto 90% of the deposit amount. Banks charge 1% more than the interest rate payable on the fixed deposit scheme. Overdraft in this case, will be available for the tenor of the FD.
- Insurance Policy as Collateral: On life insurance policy, the amount for overdraft is calculated on surrender value of life insurance policy.
- Overdraft against Salary: Banks selectively offer temporary overdraft facilities against salary of an individual. Nearly upto 50% of the monthly salary, adjusted against the salary credit every month.
- House & other Property as Collateral : The bank feels comfortable in approving limit up 75%-80% on residential property. 65% on commercial and industrial property and 50%-55% on vacant land.
- Use of Equity as Collateral: Banks sanction a lower percentage on stock, against current market price because Stock prices are volatile.
This is also called a Clean Overdraft. Here the overdraft limit is set, without any security, based on businesses having proper banking transactions. These are given to selective customers, who have a long standing relationship with the bank, and have impeccable transactions.
In case of retailers, Overdraft can also be claimed against the card swiping transaction of the business. Incase of Unsecured OD, interest rate is higher when compared with Secured Overdraft.
Overdraft facilities can be applied with your existing banker, or any public or private sector banks, just like applying for a loan. Banks, assess the merits of the case, and sanction an overdraft facility- which is a revolving credit to the customer, against Stocks, book debts and collateral security. The limits are sanctioned for a period of one year, and renewed every year, depending on the health of the business. In case, the business is not doing well, the overdraft limit may be recalled, by issuing a recall letter, and the customer asked to repay the outstanding dues.
If the business does not repay the overdraft, then, the stocks, book debts or collateral security shall be confiscated for realization of dues
Bank charges processing fees of 0.5%-1% of the loan amount apart from interest rate, variable as per the bank’s lending rate.