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How does an overdraft loan like SBI Maxgain work?


22 May 2022 - Contact Sayan Sircar
8 mins read

This articles describes overdraft home loans like SBI Maxgain and BOB Home Loan Advantage.

How does an overdraft loan like SBI Maxgain work?

Table of Contents

How does a home loan work in general?

A home loan is a standard term loan where a fixed amount is taken as a loan, called the principal, and then paid back in instalments, called EMI, every month. The EMI is designed to be fixed over the term of the loan. If the interest rate of the loan changes over time, the EMI will change. This point is the distinction between fixed and floating types of term loans.

Mortgage payment vs home equity

The bank gives a home loan to own the property while using it until you pay back the loan via EMIs. An Equated Monthly Instalment plan (EMI) is a standard way to pay off a loan by making a fixed payment monthly that has both interest and principal in the same amount.

EMI = Principal + Interest

In each EMI, the split of the interest and principal changes since the interest is based on the outstanding loan balance at that point, and the rest of the EMI is the principal. As the chart shows, the interest part drops off with time, and the rest is the principal. The actual numbers in the chart relate to a ₹50 lakhs home loan taken at 8% for 25 years. The EMI is ₹38,591. The down payment amount is ₹12.5 lakhs.

You can test the numbers using this calculator:

Overdraft home loan

An overdraft (OD) loan is a secured loan which is offered against a collateral like FD (very typical), home or other assets. The key feature of a OD loan is that interest is charged only on the amount you borrow and not on the amount sanctioned. We can extend this concept to a home loan as well and create a special home loan using the same mechanics as a OD account.

An overdraft home loan, like SBI Maxgain or Bank of Baroda Home Loan Advantage, is a special case of the standard floating rate loan. The OD facility allows you to park excess cash in the OD account with three main features:

  • whatever cash amount you park in the OD account reduces the effective principal on which the interest is calculated. If you have a one crore loan and park ten lakhs in the OD account, then interest is only calculated on the book balance of 90 lakhs. This feature reduces the loan tenure and reduces the total interest paid. Even if you keep money in there for a day and then take it out, you will save interest
  • the amount in the OD account is reasonably liquid and can be used for day-to-day expenses, savings for short term goals, keeping your sinking fund as well as the EMI buffer fund. You can put in money anytime and can remove it anytime as well
  • the interest rate of the OD loan is currently 0.4% higher (e.g. for SBI as a lender) than term loans

SBI Maxgain type Overdraft loan

OD loan Terminologies

  • Drawing Power (DP): This is the outstanding balance of the loan or simply the principal to be paid back
  • Surplus parked: Extra amount kept in the OD account
  • Available Balance (AB): Surplus parked + Accrued interest savings.
  • Book Balance (BB): Drawing Power (DP) - Available Balance (AB)
  • EMI: The EMI of the loan that consists of Principal and Interest. The EMI does not depend on any surplus parked amount and will remain constant throughout the loan tenure, assuming the interest rate does not change
  • Beginning and Ending Balance: These numbers (they are the same), are essentially the amounts you owe to the bank. As you pay, the principal reduces. The ending balance of the current period becomes the beginning balance of the next one. Ending balance = Beginning Balance - Principal Component of the EMI in this month
  • Interest part of EMI: The interest component of the EMI. The calculation is against book balance on a daily basis. This is the key benefit of the OD loan since the interest is lower than the interest if there is no surplus amount parked. If the interest is lower, automatically, the principal part of the EMI is higher and goes on the reduce the DP faster.

There will be a time when the ending balance will become zero due to the fact that the entire principal, less the surplus parked in the OD account, has been paid. At this point, if you do not need the money in the OD account, you can simply prepay the loan using the surplus and close the loan.


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Nuances if your loan is partially disbursed

If your loan is taken for under construction property using something like a Construction Linked Plan (CLP), the undisbursed loan amount is a part of the Available Balance. You need to know that in case of a CLP, you cannot take out the surplus amount from the OD account. You can do so only once the undisbursed amount becomes zero.

If you are paying the complete EMI on such a loan which has been partially disbursed, the interest part of the EMI is calculated on the book balance which is now lower than the sanctioned amount. For example, for a 50L sanctioned amount and 15 year outstanding loan, the EMI is ₹44,941. If the disbursement is only 20L, then the EMI is same but the EMI of a ₹20L loan is only ₹17,977. Hence the difference of ₹44,941-17,977 will go as a extra payment to the principal reducing both the tenure and the interest. Therefore if you have taken a CLP loan with OD facility, always pay the full EMI from the beginning instead of the pre-EMI interest option where you pay only interest.

Tax benefits on OD Loan

All home loans have the following tax benefits:

  • Section 80C deduction, up to ₹150,000/year on the principal repaid
  • Section 24 deduction, up to ₹20,000/year on the interest
  • if the loan is taken jointly, each borrower can apply for these deductions

For OD loan, the amount parked in the OD account is not eligible for either Section 80C or 24 deduction. The actual principal and interest repaid in the EMI are eligible. The bank will provide an interest certificate which will capture this interest and principal repaid information that will help you in tax filing.

Using the OD loan smartly

Parking any amount of cash in the OD account, even for a day, will reduce the total interest you need to pay over the loan’s lifetime. This benefit has to be balanced vs the higher interest rate of the OD loan against the interest saving using the methods below.

Sinking fund

A sinking fund is used to save for periodic expenses. These are known costs that are usually mandatory (insurance payments), but a few can be discretionary (like mobile phone replacement). The key here is that the expense is periodic at a frequency lower than once a month. Periodic expenses can be once a quarter, once every six months, annual or once every 2 to 3 years. You could park the sinking fund in the OD account and fund your periodic expenses from there.

Read more here: Budget 101: How to save for periodic expenses: the sinking fund

Short-term goals

Glide Path example

As per the asset allocation plan for goals based on the goal horizon (when the money is needed for the goal), we need to move the corpus to safe options as the goal comes closer. If we park this amount in the OD account, there will be significant interest savings if the goal amount is large. If you are using the Arthgyaan goal-based investing calculator, you can use the park the part of your debt SIP that is due for the next five years in this OD account. The cash allocation section in the bottom right of the image below from the calculator shows the amount that you can hold in the OD account.

You can keep the cash holding in the OD account

Read more here: Budget 101: How to save for periodic expenses: the sinking fund

Parking surplus cash

You can use the OD account as the everyday expenses account for running the monthly household expenses. However, please remember that ATM withdrawals are not free as it is an OD account. Hence you should use this account only for online payments.

In the next part of this article, we have covered how to choose between fixed, floating or overdraft home loans here:

First time home buyers: should you choose fixed, floating or overdraft type home loan?

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This post titled How does an overdraft loan like SBI Maxgain work? first appeared on 22 May 2022 at https://arthgyaan.com


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