What is Overdraft?
An overdraft is a credit facility provided by lenders (Banks and NBFCs) that allows account holders to withdraw money beyond their account balance. It acts as a short-term loan, providing financial flexibility when you temporarily need extra funds. Unlike a traditional loan, an overdraft can be used as needed, and you only pay interest on the amount overdrawn.
How is Overdraft Interest Calculated?
Overdraft interest is typically calculated on a daily basis using the following method:
Example Calculation:
- Overdrawn Amount: ₹50,000
- Annual Interest Rate: 24%
- Daily Interest Rate: (24% ÷ 365) = 0.0657%
- Daily Interest: ₹50,000 × 0.0657% = ₹32.88
- Total Interest for 30 Days: ₹32.88 × 30 = ₹986.40
Benefits of an Overdraft
- Provides instant access to additional funds during financial emergencies
- Flexible borrowing with interest charged only on the overdrawn amount
- No need to apply for a new loan for short-term financial needs
- Helps manage cash flow gaps in personal or business finances
Disadvantages of an Overdraft
- Can lead to a debt cycle if not managed carefully
- Repeated overdrafts may negatively impact credit score
- Lenders may charge additional fees for overdraft usage