Banks allow parking extra cash in home loan account to reduce interest, but should you

You're listening to a Mint podcast brought to you by HD Smart Cast. You have finalized a dream home. Now you want a home loan that can help you fulfill that dream. And you want one that preferably comes with a floating interest rate. When you approach a bank, the relationship managers offers a rather attractive proposition. He tells you about a home loan that lets you temporarily park surplus cash in the loan account, whereby the outstanding principle is reduced by an equivalent amount and thus reduces the total interest in the loan. Now, the best part is that you don't actually have to part ways with your liquid cash, as is the case with the prepayment, because you can withdraw the deposit amount anytime you want. What's more, there are no charges at all for taking this facility. You can withdraw the full amount whenever you want free of cost. Does this sound like a good deal? It certainly ought to be. This product is called home loan with an overdraft facility and it is offered by most banks as a stand alone product apart from their regular home loans, for instance, Axis Banks Super Saver loan, SBIS Max Gain and ICICI Banks Money Saver. In today's episode, I have invited Nanda, DGM Communications and Bank Bazaar to breakdown the OT facility on a home loan. Hi, I'm Shipra and welcome back to Why not Mint money? Welcome to Why not Mint Money, a personal finance podcast where we help you understand basic money concepts and share strategies for you to build your wealth. So let's get started with your money journey. Hi Nanda, welcome to why not mint money. Thank you, Shipra. Pleasure being here. So now let's start by you explaining to our listeners what an overdraft facility is. So overdraft facility is one of those things that make lives easier for a lot of people who have very varied cash flows. Very simply, it's a line of credit, pretty much like a credit card. It's not a credit card, but it functions in a very similar way. So you have an account which has a minimum balance, right? Your every SD account tells you that there's only so much money you need to keep in the bank account as the minimum, right? You can't withdraw below that. So what an overdraft does is it very clearly tells you that, hey, it's OK if you want, you can actually withdraw a little more than that. But this is the maximum that you can withdraw. So you, if you have only ₹10,000 in your account, you can still withdraw, say, 60,000 because you have an overdraft facility of another 50,000. So this is this additional amount that you withdraw is not part of the money that you've put in your account. It's a line, credit line that the bank extends to you, but you still have access to those funds. So very simply, that's what an overdraft account is, right? Got it. So it's like a perpetual credit line you have on your account, bank account, Yes, yes. Now, how does it work in the context of a home loan? In the context of a home loan, what happens is your home loan typically gets connected to your account, right? You have sometimes a salary account or you have another business account or something to which your home loan gets typed. In case of an overdraft home loan, your home loan gets connected to your overdraft account which double S up as your current account or your savings account. So what happens is in this case, every payment that gets made to your home loan, such as your monthly EMI, for instance, gets paid into your overdraft account instead of, you know, your salary account that that is basically the difference. And pretty much like any other overdraft account, you also have the ability to put additional money over and above what you already pay as your e-mail. So that's basically what a home loan overdraft overdraft on a home loan as well, right? And I think that is the main beauty of overdraft based home loan that, you know, you can park whatever surplus cash you have and you that helps you reduce interest on the total home loan interest. So can you tell our listeners a little bit more about it? How does that work? Yes. So in any overdraft account, whether it is an overdraft account associated with your SP, whether it is an overdraft with your salary account or whether it is with a home loan or any other, you know credit product, what happens is your interest is calculated on a daily basis and it is charged to you at the end of the month. So if your EMI said you say on the 10th of every month your outstanding balance is calculated, the interest is calculated on whatever outstanding balance is there on a daily basis. So on one day if your outstanding balance is 40,00,000, the interest gets calculated based on 40,00,000. On the next day if it is 35 then it gets calculated on 35 and all of this at the end of the month, you know you get to see what is the overall interest you've been charged for all the 30 days based on whatever your outstanding balance was on individually. So that is basically how the interest on overdraft home loan works, right? Similar to other home loan products, it is also a reducing, you know it's based on the reducing principal pattern. So what happens is every month you are expected to pay an EMI. The EMI obviously brings your principal down. Any surplus that you put in the overdraft account also goes towards your towards bringing down your principal, which means that if there is a lot of surplus in that particular month, your interest that's accrued over that one month is going to be a smaller amount. If you not put a lot of surplus, your interest becomes smooth. That's right. So in this case, what exactly is the credit limit that is available to the borrower because here the home loan works on reducing, you know, outstanding balance. So when banks issue you a loan, they also set what is an amortization schedule for the repayment of the loan. Which means that if you have the If you have taken the loan at a particular rate of interest for a particular period of time, then every month there should your principal should reduce by a certain amount. Now this even in the case of an overdraft loan, you cannot change this amount by which your interest month on month needs to reduce. However, you have the flexibility to put parts surplus funds, which means that your principal reduces much faster. Now, anything additional that you have deposited in the account, that is money that you will be able to, you know, withdraw at any point in time. That is money you will be able to make use of repeatedly over and over again. But you will not be able to Evergreen your account, which means that at the end of four years, if you're supposed to repay say 4,00,000 of rupees to the bank as towards your principal, you will not be able to withdraw an overdraft amount. You know that would be more than that or that will be, you know, that will cause your principal outstanding to go beyond that 4,00,000. So that is how the flexibility in the overdraft loan actually works right now. If we were to, you know, keep the the benefit of having a credit line at your disposal aside and just look at the part where you know, you're allowed to pack your surplus funds whenever you want and you know, withdraw it whenever you want. And then of course it helps you in the process. It helps you reduce the interest. You know, why not just make a prepayment and be done with it? What if the key requirement is not a credit line and if somebody's just taking it for this the other facility. So in that case, why not just make a prepayment? That's a very good question. And The thing is when you make a prepayment, and prepayments are very, very crucial for home loans, right? Because that's what helps you stay on top of your loans. So prepayments are very important. But what happens in case of a prepayment is once you make that prepayment, you lose that liquidity. You can't get that money back. In case there is an emergency, what happens is you need to take a fresh loan or you need to break your investments or you need to find another source of funds. So whatever you amount you make as a prepayment, that's gone, you're not getting it back. But with an overdraft loan, you do have the flexibility that you know whatever money is there, you park it in that account. It goes towards reducing your interest in case you have an emergency, in case there's a cash flow issue, you can withdraw it and you can use it for other things. So that's one thing. The second thing is lenders do not allow you to meet prepayments at random. Repayments come with very specific terms and conditions, right? Some lenders may tell you that you can make only a certain amount as prepayment, right? Right. As in there's a certain minimum amount that you need to make as a prepayment. So some lenders would say you have to prepay at least twice your EMI. Some people would say it has to be at least 1,00,000. So there are very clear criteria on how much of A prepayment can you make. The 2nd limitation is how frequently can you make a prepayment. Now, it may not be possible for everybody to make a prepayment on a quarterly basis. Many people may find it easier. OK, I have 10,000 extra, why don't I just put it towards my home loan? But your lender does not allow you to do that because there is a minimum that you have to pay. And secondly, there's only so many times you can make a prepayment. Somebody would say once a quarter, somebody would say once a year. So there are both these limits on the amount and on the frequency the overdraft loan takes that you know that constraint away, which means that even if you want to make a prepayment of 10,000, go ahead, there is no problem. If you want to make prepayments every five days, that's also fine. Again, there's no problem. So this is one place where, you know, an overdraft loan scores over making prepayments in case of a regular loan. That's right. OK, so the second part is, of course, very convincing. But about the first part, you know, why not park your money in an FD? It's still liquid, it's still earn you interest instead of parking it here. If you park your money in an FD, you earn an interest of around six percent 7%. You know, you do a lot of math and you go and pack it in a really safe for AAA rated company FD and on a good day you earn 8%. Yeah, home loan is always going to be more than your FD will never pay you as much as you know your home loan is going to so you you anyway going to spend more on your loan than what you're going to earn from your FD. So see, there's no straightforward answer to this. It is always possible that you take the, you know, take the funds that are available to you and you invest them in instruments that return much more than you know what you spend on your home loan. It is possible and if it works for you, absolutely go ahead and do it. But that does not mean that you know at every point you would be able to do that. There is. There are times when you know these, especially when your cash flow is a little confused, when you're not sure that the money is going to come in or maybe you're going to need some funds at a later point in time, maybe three months down the line or a few weeks long down the line in case something gets delayed. At that point, you're not going to go around breaking your FTS because that's going to cost you a penalty. That's going to bring down your rate of interest. But if you have the same amount in an overdraft loan, nothing like it that that liquidity that you get that's that is that's important to a lot of people. That's right, that's right. I think it's also equivalent to, you know, like how you would not put your emergency fund in an FT because of the same reason. But if you, if you were to keep it, sure, then you have the liberty of withdrawing it in an emergency versus say you make a prepayment, you don't have liquid money anymore. And if you need the fund, then you take a principal, sorry, personal loan, which is of course going to be the interest is going to be way higher than the home loan interest that you're saving. Absolutely, absolutely. See the whole argument of prepayment versus, you know, investment, that's a very nuanced one. And unfortunately it's also one that cannot be answered without sitting down pen, paper, calculator, Excel sheet and actually comparing what the savings are going to be like. So it's a good idea and it's not. It is definitely not the case that anytime you have some money, you should immediately think about prepaying your loan. No, if you have a plan in place so that your investment would earn you a great deal more than the savings that would come from a prepayment, definitely go for it. But whatever you choose to do, make sure that it's not just your gut instinct, it's actual calculations that you've done based on your situation, based on the rate of returns, based on what the investments look like. And then take that off. That's right. Now, for borrowers, this sounds like a good deal, You know, the flexibility that you get and then you know, you also keep to get your money liquid and at the same time your interest is getting reduced. So there has to be a catch. You know, there, I am sure that the bank is also making money out of this somehow. So what is the catch here? Of course there's a catch there. There will always be a catch. I mean, whatever you do, that's going to be your flip side. So for this, the first thing is the interest rate. For most overdraft loans, the interest rates tend to be higher around .5 basis, I'm sorry, 50 basis points. This is the case for most overdraft loans that we'd see. That's the general trend. There may be one of which is available at the same interest rate as a regular home loan, but generally home loan rates, overdraft home loans tend to be around 50 basis points high. So that's one thing. The second thing is it also depends on how much surplus money you have, how regularly you're able to put it. And you know, if you have a lot of surplus money that you can park in the account for say 15 days in a month, yeah, that's going to mean that you save on a lot of interest. But if you have only a very small amount that you can park as surplus on a monthly basis or on a regular basis, then the amount of savings that you would make is going to be much smaller. So there is this uncertainty in how much is it that you would actually end up saving by using an, you know, overdraft home loom. So unless you're very clear that there is a significant surplus that you can put to use, you can't be sure you know how much it is that you would be usually saving. The third thing is the complexity of the product. It is not necessarily very straightforward. Yeah. So like we mentioned earlier, instead of an SD account, it gets tied to an overdraft account. Yeah. So the money keeps getting deducted from your overdraft account time and time again. But the problem with that is exactly how does it work? Different lenders may have different ways of doing things right? So in case of some lenders, what happens is whatever is the surplus line in the overdraft account, your EMI keeps getting deducted from the surplus. Other lenders would tell you that you know there is an ECS and it's going to get deducted month on month either from the OD account or from another account that you specify. So there's a difference where it may be very slight, but it exists. Then there's also this thing about there is no interest that you're earning on the money that's already lying in the account, right? So that that's another thing that you need to kind of think about. So there are these slightly complex things about how how this account actually operates. So understanding all these integrities and understanding whether this is the right account for you, the right kind of facility or the right kind of instrument for you to take credit that kind of, you know, adds to the whole thing. And finally, there's also the credit score aspect, right? In case of a regular home loan, it's very cut and dried. You have your account, usually your salary account or your, you know, designated account from where your money goes month on month. You know that On this date the money is going to go out and so much money needs to be there and it will just, it's very cut and dried. You miss it, you default your credit score. Thanks. In case of a overdraft home loan, again some banks have a fixed EMI that they deduct every month and that may make things simpler for you, but a lot of banks actually recalculate your EMI on a monthly basis depending on what is your loan outstanding. OK, your principal outstanding, right. So again, that does not give you a clarity on how much money is going to get deducted every week. So if there are a lot of withdrawals, a lot of deposits, a lot of to and fro happening in that particular account, then it becomes really difficult for you also to gauge what is the exact situation of the account. And if there is mismanagement in some way, because it is complicated, it could have an impact on your credit score as well. Oh, right. That's, that's actually very interesting. So these are the different scenarios in which your OD based home loan, no matter how good it sounds, may not work for some people, you know, in some situation. Yeah, yeah, that's right. So very Simply put, an OD based home loan would work very well for people who have say, you know, if it's a double income or multiple income family and there are funds to park even if it's salaried or otherwise. But if you do not have a lot of surplus income, then an OD based home loan isn't gonna work for you. If you're a business person, if you have a lot of fluctuation in your cash flow, an OD based account is gonna work for you. If that's not the case, if your cash flows are very streamlined, there's very little excess. Basically it works on surplus. If you have surplus, it's going to work for you. If you do not have surplus, it's it's not going to work for you. Yeah. The extra interest is not worth it because you might just end up shelling out extra. Yes, yes. Everything that you perceive that you would save month on month or year on year or over the period of your loan, that may not be your perceived savings and your actual savings may not be the same because of your cash flow. That's right. That's right. So like any other financial product, I mean to sum it up, this is also not a product which has a straight away answer or whether it's going to work for you or not. Like you said, like every other product, the details, the real magic is in the terms and conditions. Yeah, you need to understand that. Yeah, yeah, you actually need to like sit and calculate, you know, if the Max is going to work out for you or not, especially because you are going to pay a small premium for for opting for this product, right. OK. So that brings us to the end of today's episode. Thanks a lot, Nanda, for joining us. This has been very insightful and informative. I'm sure a lot of listeners will have a lot of takeaways from this episode. So thank you very much for joining us today. Thank you, Shipra. Thank you for having me on board. That brings us to the end of today's episode. If you would like to know more about this topic or make a suggestion of a personal finance topic that you would like us to cover, I can be reached at Twitter under the username of Shipra Singh Saurat and on LinkedIn at Shipra Singh. Thank you for tuning in. See you in the next episode. To stay updated on this podcast, follow us at Hdsmartcast on all the major social media platforms. To listen to more such podcasts, log on to www.hdsmartcast.com.