Any business big or small requires easy access to finances for running smoothly. Most business owners have to rely on business and personal loans which comes with high interest rates to meet their short-term finance requirements. An overdraft facility offers a helping hand to owners with current accounts with good transaction history. Overdrafts have some drawbacks too, as most are offered against mortgages and for a very short tenure. Unsecured dropline overdraft facility is a relatively new product line aimed at business persons to help them meet their irregular and sudden funding requirements.
It is wise to understand how it functions and what are its eligibility.
- Overdraft means withdrawing additional funds from your bank account, similar to a short-term loan. If one has a current account, you can draw money to a certain pre-determined limit under the overdraft facility, for business requirements like working capital or expansion. You will have to however, pay an interest on the extra funds withdrawn. For an overdraft, the interest rate is linked to the base lending rate of the bank.
- Dropline overdraft combines the features of term loans with overdraft facility. In a dropline overdraft, the long-term overdraft loans can be extended for a period of up to 10 years. They only have a one-time processing fee similar to a term loan. Banks offer overdrafts or dropline overdrafts against a collateral security, which can be insurance policies, property, or any other financial instruments as stocks and mutual fund.
- Unsecured dropline overdraft is the third-generation overdraft, where the bank offers dropline overdraft with no collateral. Here your personal guarantee as a business holder is taken as the security for the overdraft. If you have a good financial track record, then banks and NBFCs can offer unsecured dropline overdrafts of up to Rs. 50 lakhs for your business needs.
Eligibility criteria for unsecured dropline overdraft
Any businessperson owning a proprietorship, partnership, or private limited company, and a current account with good transaction history with the bank is eligible for an unsecured overdraft.
Usually banks require these criteria –
- minimum of three years in business
- a clean track record of business
- income-tax returns of the business
- an audited balance sheet
Advantages of unsecured dropline overdraft
The unsecured dropline overdraft has many benefits –
- there are no collateral guarantee obligations
- No regular monthly repayments process like traditional loans
- You have to pay interest only on the amount withdrawn
- Rate of interest for overdraft is much less as compared to personal loan and other unsecured business loan.
Difference between Loan and Overdraft
When one has to borrow money either from the bank or a NBFC, one should understand the difference between loan and overdraft (OD) and their benefits.
- An overdraft facility is given only on current accounts and it works like a credit card for a business, where the amount is withdrawn as per the requirement which may vary every day, here there is a specified withdrawing limit. Whereas, a loan is a fixed amount of capital borrowed from the bank for a predetermined time period and has consistent repayments.
- In overdraft, the interest rate is charged only on the overdraft amount withdrawn and not on the limit of the overdraft facility. While, for Loan the interest is charged on the entire amount borrowed, regardless of the utilization. The interest charged on overdraft is also higher than for loans.
- An overdraft is given only for the short duration and amount withdrawn is small and limited. Whereas, loan can be for a large sum and for a longer time period.Loan is ideal for investments like expansion of new machinery or new building.
- Overdraft is more flexible with its repayment option, where a lump-sum can be repaid anytime but your credit limit can be affected depending on your credit score. While a loan is paid regularly and within the stipulated time period in the form of Equated Monthly Instalments (EMI).
Overdrafts are more suitable for smaller or emergency expenses and day to day running of the business. Loans fulfills the requirement of planned purchases with long term payment option.