Temporary Overdraft – Meaning
An overdraft facility is a credit facility where the borrower can withdraw more money from their bank account than the available balance. The banks extend an overdraft limit, and the borrower can withdraw up to the extended limit as and when required.
A temporary overdraft or a TOD is a bank product that falls in the subcategory of an overdraft facility. While a regular overdraft is extended for a longer period of time, a temporary overdraft is usually extended from anywhere between 30 to 90 days as per the requirement of the account holder. For example, if the bank has given its account holder a 30 days temporary overdraft, and if the account holder uses his overdraft facility, he must repay the overdrawn amount within 30 days.
Another peculiar feature of a temporary overdraft is that it is usually extended to people and not business entities. This product is specially tailored for personal finance and is not a very prevalent commercial finance option.
Pre-Requirement of a Temporary Overdraft
Bank usually asks for collateral to extend a temporary overdraft facility. The banks consider the following assets as collateral –
If a person has a personal property such as a house, land, or holiday home, he can mortgage such real estate to attain a temporary overdraft facility. The banks extend 50% to 60% of the property value as an overdraft limit as per bank policy. This means if a person mortgages his apartment worth USD 50,000.00, then he will have an overdraft limit of up to USD 25000.00 to USD 30,000.00.
The banks usually give an overdraft limit of up to 70% of the fixed deposit value. In the above example, if the bank has a fixed deposit of USD 50,000.00 as a mortgage, the overdraft limit can go as high as USD 35000.00.
Banks consider life insurance policies as collateral against overdraft limits. Like a fixed deposit, banks give up to 70% of the maturity value of the insurance policy as an overdraft limit.
Though equity stocks are risky, many banks consider equity stocks as collateral. The bank decides the overdraft limit after a thorough analysis of the type of stock that the borrower is offering.
Banks offer a temporary overdraft facility against borrowers’ monthly salary. Consider your monthly salary as USD 5,000.00 per month. Then you will be eligible for overdraft up to USD 2,500.00 against the salary.
Advantages of a Temporary Overdraft Facility
There are many advantages of a temporary overdraft as follows –
Short-Term Financing Option
A temporary overdraft is an excellent short-term financing option. Let’s consider a situation to understand this well. It is Black Friday today. You went to your local electronics store and found out that the latest iPhone worth USD 1000.00 is available at USD 700.00. You check the balance in your account. Oh dang! You got only USD 600.00, but you really want to buy this phone, and you will not get this kind of discount soon. Suddenly you remember that you have a temporary overdraft facility on your account. So you overdraw your account and buy the iPhone. You will receive your salary next week anyway so that you can repay your overdraft then.
No other bank credit product finances personal needs for such a short period of time.
Though a temporary overdraft facility is more expensive than a regular overdraft facility, it is usually more affordable due to its usage. Let’s continue our above example for better understanding. Black Friday is over, and you got your favorite phone. Next week when you get your salary in your bank account, your overdraft is repaid, and the applicable charges of USD 10.00 and interest* of USD 0.20, i.e., a total of USD 10.20, are deducted from your account. It’s still a neat USD 289.80 discount on the original price (Discount of USD 300.00 – overdraft charges of USD 10.20 = USD 289.80). Thus we can say that in perspective, a temporary overdraft facility can be very affordable at times.
*INTEREST CALCULATION @ 10% P.A. for 7 days overdraw of USD 100
= 100 X .10 X 7/365 = USD 0.20
Read more about Overdraft Interest.
Useful in Emergencies
A temporary overdraft facility is very useful in emergency situations because of its ease of access. In case of an emergency situation such as an accident, disease, or death, it takes time to get money from the insurance. A person can easily access his temporary overdraft for the required fund during the waiting time.