The allure of secured overdraft loans

With lower interest rates and flexible repayment options, it's time to give secured overdraft loans a shot.



What do you do when there is an unforeseen need for cash? Do you approach a bank for a personal loan? Do you borrow against your credit card? Both these are probably the last options you should be considering. The interest on a personal loan is anywhere between 18-24 per cent per annum. If you are paying EMIs for a credit card loan the interest can go as high as 36 per cent per annum. High interest rates apart, there will be prepayment charges on these unsecured loans too. Moreover, CIBIL (Credit Information Bureau) will also make a prompt note of any personal loan you avail and the next time you knock a banker's door, this personal loan might weigh against you on your credit score.

So, what is the way out? Is there a better option? You can avail secured overdraft (O/D) loans which overcome most of these disadvantages. If you have assets in the form of property, equity shares, gold and the like, you can take an O/D loan by pledging these assets. With this option, you may not only get a lower interest rate but a flexible repayment option too.

How does it work?

To start with, banks may require you to open a current account in case you ant to apply for an overdraft loan . You will be given a credit line in the current account which you can use whenever you need to . This is unlike a term loan, where the loan amount is disbursed as one lump-sum. Mr Biju Pillai, Executive Vice President and Business Head, Loans (Personal, Gold, Home and Loan against securities), HDFC Bank, says, “In an overdraft loan, the customer is provided with a credit line which can be drawn down and repaid by him at his convenience. The repaid principal amount will then be available as a credit line for future use.” Overdraft loans have no fixed repayment schedule. They come with annual renewal options.



In contrast with personal loans, there is no pre-payment charge here. In personal loans products, pre-payment penalty is as high as 4 per cent of the outstanding loan amount! And as principal can be repaid at convenience in an overdraft loan, the borrower has to service only the interest component. Further, interest here is calculated on the daily outstanding amount in the overdraft account (amount utilised).

Another highlight of these secured loans is also that they are more favourable for your credit score than unsecured loans. CIBIL's TransUnion score which every lender accesses these days to weigh a borrower's ability to repay is impacted by the type of credit chosen by the borrower. Ms Harshala Chandorkar, Senior Vice President – Consumer Relations, CIBIL, says, “When a borrower's credit history has more secured loans, the borrower's score is likely to be higher, subject though, to timely and regular repayments of the loan EMIs.”

The process of getting an overdraft loan is simpler and faster compared to a personal loan. The borrower has to fulfil the KYC requirements and sign up the lien document.

After re-payment of the principal, the recovering of all charges and interest on the O/D given, the banker will hand over the pledged security to the borrower. In case of shares and MF units, the banker makes a request to the depository participant or the AMC to remove the lien.

What can be pledged?

The generally accepted securities are fixed deposits, equity shares, mutual fund units, RBI bonds, gold jewellery and property.

Some banks even accept endowment policies of Life Insurance Corporation and NABARD bonds.

When shares are given as security, a request has to be made to the DP to pledge shares in favour of the banker. The borrower however continues to enjoy benefits such as dividend, bonus, etc.

The O/D limit here keeps changing as the market value of the pledged stocks change. When pledging property, a copy of the title deed needs to be given. For gold the banker will have an assayer to test the purity and grammage of gold.



How do they compare?



Interest rate doesn't vary much between securities. Interest on overdraft loans is anywhere between 13-15 per cent per annum. What changes is the processing time and the loan-to-value (percentage of the pledged security that is given as loan).

Gold and fixed deposits get the highest credit for the value pledged. For shares, the credit may be in the bracket of 50-60 per cent and for property, around 65-70 per cent.

And if time is crucial for you, gold loan may be the best option.

There is no document verification involved in gold loans and some banks claim to process it within an hour! O/D on fixed deposit with the same bank is also an option where the processing may be complete in a day's time.

But, if it is your demat shares or mutual fund units, the process may take more than a week as it has to pass through the DP (depository participant) and the respective fund house.

Though secured overdraft loans look appealing, you should exercise some restrain here too, says Mr Biju Pillai. “The borrower must exercise discipline in monitoring and managing the overdraft draw downs and periodic repayments to ensure he doesn't get caught with margin calls or over due interest. At the very least, it will lead to increased cost of borrowing. In certain situations it can also lead to liquidation of collateral by the lender.”

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