Which home loan is best – think smart , think overdraft

Glad you are wondering which is best home loan to opt for. Home loan is long term liability and we should be very careful in choosing same. In this article, we will see overdraft loan which offers better features than standard home loan.

What is overdraft?


Overdraft or commonly referred as OD is facility that is offered to customer to use pre approved amount as loan on need basis. In standard loan, bank or NBFC generally will disbursed loan amount upfront and so whether you use it or otherwise you will need to pay the interest. For example, say you need some money between 5 to 7 lac to start a business but are unsure of exact amount. You will generally take up loan of 7 lac. Now you may end up needing say only 6 lac but since bank has already given you 7 lac, you have to pay interest on full amount. You may decide to pre pay extra 1 lac but that is not very easy. Bank may have some minimum initial period, prepayment penalty etc.

Overdraft works in a different manner. Here too you would apply for loan (or we can say overdraft) of 7 lac. But its just a technical limit and not actual disbursement. What that means is bank is allowing you to use upto 7 lac on need basis. So when you need say 2 lac, you use same. Your interest would be only on 2 lac. Later as you need more, you withdraw same from the loan account. As you increase the withdrawal, your interest would calculated on new amount. So basically you pay interest as you use money from loan. When you have money, you can deposit back in the loan or OD account and your interest would be calculated only on remaining amount. So even prepay is as simple of depositing money back into loan account exactly like a saving account.

Fair enough. But how does this relate to home loan?


Most of the banks offer overdraft home loan along with standard home loan products. The amount of loan approved and disbursed is what is what is your overdraft loan limit. Say you need a home loan of 50 Lac, then if you go for overdraft home loan, your OD limit is 50 Lac to start with and as you keep repaying EMIs, your principal amount would get reduced every month and so does your OD limit. Finally when you complete all your EMIs, it will become zero or this is equivalent to getting your standard home loan getting closed.

Before moving further, what about income tax benefits?


All the income tax benefits that you get will be applicable exactly same way even to this type of loan. Ultimately this is a home loan variant so ALL income tax benefit work here as well.

Overdraft makes sense for business needs but why for home loan?


Fair question. Ultimately we know what is price of home that we are buying and how much we need, then do we need this flexibility of overdraft where one can use money on need basis. Let’s see few advantages of this loan over standard home loans.

Flexibility


Flexibility that this type of home loan offers is biggest advantage according to me. See, home loan is longest financial commitment one makes. Most people would go for 15 or more years loan period. During this period, you will surely have periods when you have surplus money. May be for few months or few years but you are likely to have some extra money with you. You can put this money in your overdraft account and your home loan interest calculation would be done only based on balance amount. Say you have 50 lac OD limit and paying interest on this amount. Say your insurance policy matures and you get 3 lac. You can simply put this amount in overdraft account and then onward your interest would be calculated on only on 47 Lac instead of 50 lac.

Simplicity


You could argue that we can do same with even standard home loan by prepaying that 3 lac. But look at simplicity of doing it in overdraft. All you needed to do is deposit the cheque in this account or get ECS credited to this account and that all. If you have a standard home loan, you might need to visit the branch or fill some form or so. Here its as simple as putting money in your account. Also there is no minimum limit here. You can put anything like 1 rupee to few thousands or few lacs in this account. Maximum limit is of course your overdraft limit. Putting more money that limit does not make sense and I guess no one would do either.

Tax free interest


When you put any in this account, ultimately your interest calculation is done based on remaining principal. So your are saving on interest. If you had put same money in a FD instead, still you could have earned some interest. So what’s big deal. Interest in FD is taxed. Whereas in our case, its considered as interest saved instead of interest earned. So there is no income tax on same.

Higher rate of returns


Generally any bank would offer loan rates at higher rate compared to FD rates. So any money you would be parking in this account, would help you get more return than FD. My experience is that it would be at least 1.5 to 2 % more than FD interest rates. That too tax free, without visiting bank, at any time.

No Lock-in


Your investment in FD is subject to lock-in of fixed deposit term or you may need to pay some penalty at withdrawal. In this case however you can deposit and withdraw funds at your will. You will get interest for the period that you keep money in overdraft account.

Investment flexibility


You have full control on your extra money. At any time, you feel that you can get much better returns than FD somewhere else, you can invest accordingly. Let’s take an example. As above case, you had parked 3 lac in your overdraft account. Let’s say stock market is down and your advisor suggests to put some money in mutual fund. You have above 3 Lac available in your account and you can invest same any time. In case of standard home loan, once you prepay any amount, you can not get it back.

Prepay or Hold confusion – no more


In case of standard home loan, anytime you have extra money, there is always dilemma of whether to prepay loan or hold it for future need like child education expense in few years. In standard home loan, if you prepay, its gone. When you need it again, you may have to go for some new loan most probably a personal loan at higher rate. Here you can park money in your account and your home loan interest would immediately be reduced. When you need it, simply withdraw.

Better returns than any saving account


Once we get salary, generally we do not spend or invest entire thing at one go. Some part would be spent on day 1 then some day 5 and some on day 10…so and so forth. Money that remains in saving account will get you very low returns. Generally 3 – 4 %. Even best saving account don’t offer more than 5.5% per year. Instead start using overdraft account as your regular account, and move any money you get immediately to this account. Money remaining in this account whether for a day or week or month will earn you something in range of 8 to 9% without doing anything.

Just start using this account as primary account. Pay bills, maintenance cheques, taxes everything from this account. Without any effort, you would save some money every month. Assuming your salary is say 1 Lac. If this remains idle say for 10 days in a month. In saving account, you may get around 1,335 ( at 4%) vs 3,000 (at 9%) in overdraft. Though it is not significant, still it is better than saving. Also this is sort of interest saved so no need to pay any tax. This page gives example of your possible saving

If this is so good, why no bank is promoting same?


This is good for you but not for bank. They are here to do business and earn maximum profit. In case of home loan, profit comes from interest you pay. In any normal scenario, people would have surplus fund after initial 2-3 years of taking loan as their income rises. If they start parking money in this account, bank is losing on interest. Secondly there is unpredictability for banks. You can deposit extra money at any time and withdraw too anytime. That is not good for their cash flow management. So overall banks are much happier to offer standard home loans. In fact some banks charge around 0.1% extra for overdraft loan. Still its worth according to me.

So does all bank offer these overdraft loans


Due to competition, most of the banks offer these loans but don’t really promote neither do publicity for same. So do make sure you esquire about it before opting for home loan. In long run, you will be glad that you made this choice.

Some of the overdraft loans are as under. You can click and check interest rates and other features :

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