What is an ‘overdraft’?

Overdraft is a loan facility provided by commercial banks to customers and especially business community to overcome the day to day financial needs of the borrower

It is provided in the form of a credit limit over and above the credit balance available in the current account of the borrower

The borrower in case of need utilises the credit limit for meeting his financial obligations.

This is provided towards meeting working capital needs.

Working capital means funds required to meet expenses as mentioned below:

  • Rent payable for the company
  • Electricity charges
  • Telephone expenses
  • Printing charges, stationery charges etc
  • Transport, conveyance etc
  • Salaries payable to employees, wages payable to employees etc.,

The borrower may be a seller and there may be delay in getting the sale amount from his clients and in order to offset such delay in getting payment from the customers, the borrower requests the bank to provide overdraft facility and the limit is considered in months’ requirements. Say one month, two months or three months and this differs from one industry to another industry

The borrower has to pay interest for the overdrawn amount each month

He has to pay the entire amount at the time he wants to close his overdraft limit with the bank

When the limit is given against the security of stocks, it is known as open cash credit limit

Types of Over Drafts

There are two types of overdrafts. Collected balance overdraft occurs when you request more more than is available, usually do to a hold on a check or some other credit pending full collection. Holds also are set in new accounts, to protect the bank.

The second type of overdraft is when a check or other debit is paid against your account when there are not enough funds in the account to over it. Banks may pay that, creating a negative balance-hence, you have an overdraft. Overdrafts usually result in a fee, and quite possibly your bank will charge the check back to its source.