Home Loan Overdraft Facility: What It Is And Why You Should Consider It

Home loan borrowers who seek to lower their total interest expenses either make advance payments on their loans or move their loans to new lenders with reduced interest rates. Home loan overdraft facilities, also known as interest saver home loans or smart home loans, provide an intelligent method for decreasing your interest expenses.

Here are some of the key benefits and drawbacks related to adopting home loan overdraft facilities:

Benefits

Prepayment Through Parked Surplus: Through this facility, borrowers can use their surplus funds to deposit into the linked home loan overdraft account which operates as either a savings or a current account. The excess funds in this overdraft account act as a prepayment against the outstanding principal, since the average balance maintained in this account is deducted from the outstanding loan amount at the time of calculating the interest component on the loan. This reduces the overall interest cost on the loan.

Says Ratan Chaudhary, head of home loans, Paisabazaar: “Under the home loan overdraft facility, an overdraft account is opened, usually in the form of a current account, and it is linked to the home loan account. Borrowers availing of this facility are allowed to deposit their surpluses in the overdraft account. The balance maintained in this account is deducted from the outstanding amount in the linked loan account while calculating the home loan interest component. This helps in reducing the total interest cost for the home loan borrower.”

Helps Maintain Liquidity: Home loan overdraft facilities enable borrowers to extract their surplus funds to achieve their financial objectives or address other monetary requirements. The savings and current account format of these accounts provide immediate liquidity to customers who hold them.

“The biggest advantage of the home loan overdraft scheme is the liquidity it offers. If you make part payments against your regular home loan, it reduces your outstanding principal, but that money will not be available to you again. However, with the overdraft scheme, any surplus amount you park in the home loan overdraft account is available for withdrawal any time,” says Adhil Shetty, CEO, Bankbazaar.com.

Saving On Interest: The other biggest benefit is the savings on interest. If you keep making regular repayments, your principal, and therefore the interest you pay on it, keep reducing. This translates into substantial cost savings.

Parking Of Emergency Fund: Borrowers can also use the overdraft facility to park their emergency fund. The interest cost savings generated through the overdraft account would be higher than the low risk and highly liquid alternatives, such as savings accounts, fixed deposits, liquid/overnight funds, or other short-duration debt funds.

Drawbacks

Higher Interest Rates: Home loan overdraft products require lenders to apply marginally increased interest rates because they provide customers with enhanced liquidity and flexibility. 

The home loan overdraft facility becomes beneficial only when you calculate if the interest accrued from surplus funds in the overdraft account exceeds the additional interest charges of this loan type. The greater interest charges from the home loan overdraft option will generate higher interest costs compared to the standard home loan rates.

Adds Shetty: “Home loan overdrafts usually tend to be more expensive by at least 25 basis points (bps). So, if you do not have a chance to generate a regular surplus amount, the home loan overdrafts may not be the right choice.”

No Tax Benefit: From a tax perspective, the surplus amount deposited in the home loan account does not qualify for rebate under Section 80C of the Income-tax Act, 1961, as it is not treated as prepayment. Interest saved is also not tax-deductible under Section 24 of the Act.

Who Should Opt For Home Loan Overdraft Facility?

Home loan applicants planning to prepay their loans in the future to reduce their overall interest cost, while also retaining their liquidity to make withdrawals, should opt for home loan saver loans. The flexibility to deposit and withdraw allows borrowers to park their emergency fund in the linked overdraft accounts.

The only flip side is that their interest rates are usually higher than regular home loans. Therefore, one should opt for this facility only if the benefit of interest saving through surplus parked in the home loan overdraft account is likely to outweigh the higher interest cost of this home loan.