A home loan overdraft facility is designed by lenders, specifically for using short-term surplus money to pay off the home loan and save interest on this prepaid amount. This flexible facility gives an option to withdraw this amount as and when required.
While availing for a home loan overdraft facility, the lender links the home loan account with the individual’s savings or current account. Whenever an amount higher than the equated monthly installment is deposited in the linked account, the system automatically transfers surplus amount, to the home loan, over and above the minimum specified amount desired to be retained by the customer in savings or current account. The surplus deposits reduce the principal amount, hence reduces the interest and help in shortening the loan tenure. In case of need, you can withdraw the surplus amount from the account linked to the home loan. When you withdraw the amount from the home loan account, the outstanding loan amount is restored at a normal level with a normal interest cost.
Under what circumstances should you opt for the facility as a home loan borrower?
The assessed income considered at the time of loan may not remain the same all through. The income of self-employed or small businessmen varies with season and growth in business. Home loan overdraft facility is primarily for people with short-term surplus income. It allows you to utilise the amount to reduce home loan instead of keeping in savings or current account, with the corresponding benefit of reduction in interest outgo on the home loan. It is equally beneficial for salaried people to deposit arrears of salary, incentive or bonus to the overdraft account. Home loan overdraft facility is specifically beneficial for businessmen and high salaried persons as it provides twin benefit of interest reduction and financial cushion in emergencies. They can withdraw the surplus amount whenever needed, which eliminates the need to go for a personal loan with high-interest rates. Thus, home loan overdraft facility gives complete flexibility to home loan customer to effectively use the surplus amount without investing in low-interest savings bank or other short-term instruments.
What are the benefits and disadvantages of opting for the facility?
The overdraft facility has been formulated with flexibility as its core tenet. The borrower can also withdraw the surplus amount to meet unforeseen liquidity needs. It helps in efficiently managing cash flows and reducing the total interest outgo. People opting for home loan overdraft facility are not likely to search for other financial institutions offering lower lending rates.
The home loan overdraft facility is largely beneficial, but there are some drawbacks as well. No lender provides the flexibility of home loan overdraft free of cost. The interest rate on a home loan with overdraft can vary between 20 to 50 basis points higher than regular home loans. If you do not have sufficient short-term surplus funds periodically in a year, you will end up paying higher interest on the home loan. Hence, interest benefit on surplus funds is worked out considering the amount and frequency of such surplus, difference of savings bank rate, home loan rate and applicable higher than the normal rate on home loan.
Also, when you pay a higher amount for early repayment of home loan, you are bound to cut on your regular savings, which may not be a financially prudent step. Repayment of home loans during a longer loan period helps to generate sufficient long-term savings for the future. Repayment of loan in a shorter period is good for those who have enough surplus over and above required savings for the future.
Moreover, the repayment for home loan principal is eligible for a tax deduction of up to Rs 1.5 lakhs per year under Section 80C of the Income Tax Act, 1961. However, the additional payment of home loan principal does not qualify for a tax deduction, and you may not receive any tax benefits for the surplus payment.
What are the things a home loan borrower should keep in mind while opting for this facility?
People opting for a home loan with overdraft facility should be very cautious while analysing the total outgo. Home loans with overdraft have a higher interest rate of 20-50 basis points, on an average. If you opt for the facility and do not deposit surplus amounts on a regular basis, you may end up paying a higher amount at the end of the loan tenure. Therefore, home loan overdraft is only for people who have a large amount of surplus funds available regularly. Secondly, the amount that you pay to the overdraft account does not earn any interest; it only reduces the outstanding amount and hence, the interest outgo. If you can earn higher interest by investing the surplus in other assets, then deploying the money for home loan repayment could be counter-productive. Thirdly, all lenders do not offer home loan overdraft facility. With limited choices, you will have to choose the lender taking into account other factors such as credibility and other terms and conditions.
In a nutshell, this is a powerful product for those who have a frequent short-term surplus. If the facility is used prudently and in a planned manner, it can help you reduce the interest outgo and the loan burden.