Home loan overdraft is similar to the overdraft facility available on your savings and current account where you as a borrower can deposit extra funds. In the scenario of home loan overdraft, your account is linked with a savings account. So, when you add any surplus funds to your account, it is looked upon as pre-payment of the loan, thus lowering your interest constituent on the loan proceeds. In this way, it effectively reduces your overall liability as interest is just being levied on the outstanding dues.
Also, if required, the overdraft facility permits you to withdraw the funds whenever you require. It is generally used for the lump sum expenditures like home expenditures, healthcare exigencies, weddings, etc. The loan may get rebalanced accordingly. The prudent benefit of this option is probably the provision of liquidity. However, any increment in the outstanding due of the home loan subsequently enhances the rate of interest.
However, the interest constituent would just be incurred on the proceeds exceeding the balance for the time period it was withdrawn. To safeguard themselves from the involvement of credit risk, lenders tend to put a restriction on the allowed withdrawal amount. This usually is 25 percent of the loan proceeds, but it might depend on the financial institution’s internal policies.
How does the home loan overdraft option function?
This option usually makes sense for you if you have the guarantee to save additional funds over the regular loan EMI. Once you avail the overdraft facility, you can directly transfer the savings funds to a home loan account. As mentioned, interest payable upon the home loan gets computed on the outstanding proceeds, so the higher funds you deposit, the sooner you would be able to repay your loan.
With this option, you have the right to withdraw or deposit as many times as possible during the repayment tenure, endowing you the flexibility to manage the cash inflows. If you are unable to understand how the overdraft facility works, consider this example. Suppose you availed SBI home loan with overdraft facility for an amount of Rs 15 lakh at an SBI home loan interest rate of 7 per cent per annum. Now, if you pay a higher amount i.e., an amount more than your EMI, then your EMI and interest constituent requirement for the next month would automatically reduce.
Benefits of the overdraft option in home loan –
As the option is becoming very popular among many as an option to invest, it is important for you to understand the reasons to opt for this option.
Withdraw the surplus amount as required –
Availing an overdraft loan has various benefits. Overdraft facilities are liquid in nature. They permit you to easily withdraw the funds from your account up to the agreed limit and financial institutions allow you to do this as many times according to your convenience. This flexibility is beneficial during financial emergencies.
With this kind of home loan, you can make use of your savings bank account to efficiently cover up your additional expenditures. It is a good option for those who are not cash crunched. The pre-paid penalties can simply be avoided, thus lowering the thorough interest constituent.
Also Check: SBI Home Loan Interest Rate
Avoid the penalties –
With the overdraft loan option, the liability for the prepaid balances can simply be avoided. It is an excellent way to forgo the high cost involved in prepaying the penalties and still using the account whenever required. In the case you are not cautious, there’s a chance of making a payment of a heavy fee for withdrawing the funds from the savings bank account.
Potential to repay the home loan before the agreed upon repayment tenure –
One of the most crucial benefits of opting for an overdraft home loan is that with it you can repay your proceeds before the determined repayment tenure. It is a prudent choice if you are looking to repay the loan proceeds in just a few years. Let’s understand it with an instance.
Home loan overdraft option – an illustration.
For example, in 2018, Mr. X availed a home loan of loan proceeds of Rs 80 lakh for a repayment tenure of twenty years at a rate of interest of 8.6 per cent per annum. According to computations, he will be repaying a monthly EMI of Rs 70,000. Now, let’s suppose Mr. X holds surplus funds of Rs 4 lakh and he makes a payment partially after twenty-four regular home loan EMIs to lower the overall amount.
Prepaying the additional funds would keep the loan EMIs unchanged in regular home loan. Principal interest ratio would stay unchanged. However, in the case of home loan overdraft option, if Mr. X pays Rs 4 lakh to the bank account attached with home loan, the loan EMI would reduce to Rs 66,000 from the upcoming month, lowering the repayment tenure.
Here, the interest constituent is computed on outstanding principal constituent. So, the higher money you place in your bank account, the more interest constituent would lower.
Drawbacks of overdraft option in the case of a home loan –
For borrowers –
The major drawback of the overdraft option in the case of home loan is they are not advantageous for individuals who require saving funds. This kind of loan even has an enhanced risk for individuals who are not able to maintain their existing finances. They may require paying the whole amount back in a single lump sum, which may be tough if they do not hold adequate money. This means, if you make use of the overdraft option for the regular expenditures, it would be costly over the long term.
Higher rate of interest –
You as a consumer may often be lured for taking up the overdraft option on home loan owing to its provision of flexibility on the use of the funds when required. However, this advantage can at times cost you more. Such loans considerably contain a high rate of interest. They generally have higher rates than the standard traditional home loan.