Overdraft

Overdraft means an agreement with a bank by which a current account holder is allowed to withdraw more than the balance to his credit up to a certain limit. The interest is charged on daily overdrawn balances.

The main difference between cash credit and overdraft is that overdraft is allowed for a short period and is a temporary accommodation whereas the cash credit is allowed for a longer period. Overdraft can be clean overdraft, partly secured or fully secured.

If the overdraft is backed by an asset or property, the lender has the right to foreclose on the collateral in case the account holder fails to pay. Calls happen usually where the

  • borrower’s credit rating falls,
  • lender has reason to believe the borrower may go into default, or
  • borrower has not ‘revolved’ the overdraft in a satisfactory manner and has turned it into a hardcore debt.

An overdraft is approved only for a fixed period (usually one year) after which it is must be renegotiated. The borrower is often required to maintain 10 to 20 percent of the approved overdraft limit as cash balance in the account, and must demonstrate its continuing financial health by managing without the overdraft for a one or two-month period (called cleanup period). This is also called bank overdraft.

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