Pros and Cons of the Home Loan Overdraft Facility

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Prepayment of home loans has two critical benefits: firstly, it saves the interest outgo and secondly; it reduces the home loan tenure. However, most lenders levy fines and penalties on the borrowers for making prepayments. Not to forget, paying over the stipulated EMI amount can reduce the cash flow for emergencies.

One option to overcome these limitations is by opting for an overdraft facility. However, the question remains – is it better than the conventional home loan? 

Let’s analyze its pros and cons to find out more.

What Is an Overdraft Facility?

An overdraft facility is a loan agreement between the lender and the borrower, linked to a bank or savings account. The facility allows borrowers to withdraw or ‘overdraw’ sums that exceed the current balance in their linked account, and up to an approved credit limit.

Interest is to be paid only on the amount withdrawn and only for the time it is borrowed. Furthermore, the borrower has to provide collateral to avail the overdraft facility.

How Does It Work for Home loans?

Your home loan account with an overdraft facility is linked to a dedicated bank/savings account. Any amount deposited in home loan account – that is over and above the stipulated EMI amount – is treated as a prepayment for the housing loan principal amount, for as long as it remains there. 

During the tenure, borrowers can deposit as well as withdraw the surplus money in the account, anytime. Like conventional home loan plans, the surplus sum deposited in the account is deducted from the outstanding principal loan amount to calculate the interest payable. However, the interest is calculated daily and debited at the end of each month.

Likewise, when the borrower withdraws the surplus amount from the account (exceeding the account balance), the interest payable depends on the amount withdrawn and the period for which it was withdrawn.

Pros

  • Allows prepayment of home loans and consequently, brings down the overall loan liability by reducing the home loan interest rates and shortening the loan tenure.
  • Facility users can withdraw the surplus amount deposited in the home loan account during financial emergencies.
  • Unlike conventional home loans, there is no penalty for the prepayment of the home loan amount.
  • The surplus amount can be withdrawn or deposited at convenience, offering greater liquidity.

Cons 

  • In comparison to conventional easy home loan plans, lenders charge a slightly higher home loan interest rate in India for the overdraft facility. Thus, making it a more expensive option.
  • The surplus amount used to prepay the housing loan is not eligible for rebate under the Section 80C of the ITA. 
  • Lastly, managing the overdraft facility is difficult without a regular surplus income.

Experts suggest conducting a cost-benefit analysis to determine if the home loan interest saved on the prepayment is more than the cost of servicing a regular home loan – before settling for the overdraft facility.

Nonetheless, before buying a house remember to use a home loan EMI calculator and then apply for a home loan online or offline. This way, you will be able to check your home loan eligibility and to estimate the EMI amount, you can make a more informed choice.

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