Home Loan Overdraft Facility: Benefits and Drawbacks Explained

Reduces overall interest cost through prepayment in the form of parked surplus

Home loan overdraft facility allows home loan borrowers to deposit their surpluses in the linked home loan overdraft account, which is usually offered in the form of a current account. The average balance maintained in this overdraft account is deducted from the outstanding loan amount while calculating the interest component for the linked home loan. This helps in reducing the total interest cost for the home loan borrowers. Thus, depositing surpluses in the overdraft account plays the same role as prepayments do for reducing the overall interest cost.

Retains liquidity by allowing the flexibility to withdraw funds whenever required

Home loan overdraft facility also provides borrowers the flexibility to withdraw from their parked surpluses, as and when required, to meet their financial goals or short-term fund shortages. As these overdraft accounts are offered in the form of current accounts, they offer instant liquidity to the borrowers. This feature makes home loan overdraft an excellent option for home loan borrowers facing frequent cash flow volatilities. Such borrowers can use their home loan overdraft account to save their interest cost without compromising their liquidity for dealing with unexpected cash outflows.

An excellent instrument for parking emergency fund

The primary purpose of maintaining an emergency fund is to set aside monetary resources for dealing with unforeseen financial exigencies or to meet unavoidable expenses like rent, household expenses, insurance premiums, utility bills, etc during periods of income loss arising caused by unemployment, illness or disability. The fund should be big enough to meet those unavoidable expenses for at least 6 months. Home loan borrowers should also add their home loan EMIs of at least 6 months to this fund to ensure continued loan repayment during periods of crises. However, doing so would make the size of the emergency fund significant for the borrower. Parking their emergency fund in the home loan overdraft account would not only ensure instant liquidity, it would also generate higher interest cost savings than the returns generated from parking emergency funds in highly liquid alternatives like savings accounts, fixed deposits and liquid/overnight funds.

Interest rates are a notch higher than those of regular home loans

Given the higher liquidity and flexibility offered through the home loan overdraft option, lenders usually charge slightly higher interest rates for home loan overdraft products than their regular home loan products. Hence, go ahead for the home loan overdraft option only after doing a proper cost benefit analysis. Opt for a home loan overdraft scheme only if it results in net savings in interest cost after factoring in its higher interest rates.

No tax benefits on parked surpluses

Section 80C of the Income Tax Act allows home loan borrowers to claim tax deduction on their home loan principal repayments made through EMIs as well as through prepayments. However, the surpluses parked in the overdraft account do not qualify for the Section 80C deduction even though these are treated at par with prepayments for home loan interest calculation.

Home loan applicants seeking to reduce their overall interest cost without compromising their liquidity can opt for a home loan overdraft facility. Even existing home loan borrowers serving regular home loans can enquire with their existing lenders about the availability of home loan overdraft options. If their existing lenders do not offer home loan overdraft schemes, then they can transfer their existing home loans to lenders offering the same. Borrowers requiring large cash balances to deal with unpredictable cash outflows can also use this facility to make an optimum use of their cash surpluses.

The major flip side of home loan overdraft schemes is that their interest rates are usually a bit higher than regular home loan schemes. Thus, home loan borrowers should opt for this facility only if the benefit of interest cost saving can potentially outweigh the incremental interest cost.

(An edited version of this article was printed in Financial Express)