What is an overdraft home loan?

An overdraft (OD) 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: (1) whatever cash amount you park in the OD account reduces the effective principal on which the interest is calculated, (2) 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, and (3) the interest rate of the OD loan is slighty higher (e.g. for SBI as a lender) than term loans.

What are the overdraft (OD) loan terminologies?

The OD loan terminologies are Drawing Power (DP), Surplus parked, Available Balance (AB), Book Balance (BB), EMI, Beginning and Ending Balance, and Interest part of EMI.

What is Drawing Power (DP) of an overdraft (OD) home loan?

Drawing Power (DP) is the outstanding balance of the loan or simply the principal to be paid back.

What is Surplus parked of an overdraft (OD) home loan?

Surplus parked is an extra amount kept in the OD account.

What is Available Balance (AB) of an overdraft (OD) home loan?

Available Balance (AB) is the surplus parked amount plus accrued interest savings.

What is Book Balance (BB) of an overdraft (OD) home loan?

Book Balance (BB) is the difference between Drawing Power (DP) and Available Balance (AB).

What is EMI of an Overdraft (OD) home loan?

EMI is the Equated Monthly Instalment 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.

What are Beginning and Ending Balance of an overdraft (OD) home loan?

Beginning and Ending Balance 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.

What is Interest part of EMI of an Overdraft (OD) home loan?

Interest part of EMI is the interest component of the EMI. The calculation is against book balance on a daily basis.

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How does an overdraft loan like SBI Maxgain work?

Posted on 22 May 2022
Author: Sayan Sircar

Tags: House Purchase ; Loans

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

How does an overdraft loan like SBI Maxgain work?

This article is a part of our detailed article series on the concept of home loans. Ensure you have read the other parts here:

How can you pay the least interest and get the most tax deduction on your home loan?

This article breaks down the benefits of prepaying your home loan and how it impacts both your interest payments and tax savings.

How much time and interest do you save if you pay off your home loan using a step-up EMI?

This article shows how quickly you can pay off your home loan, and even save a lot of interest, by increasing your EMI steadily year-on-year.

Home loan tax benefits that you get when you buy a property jointly with your spouse

This article tells you why it is a good idea to buy a home jointly as a couple and it is not only the tax benefits you get.

Home Loan Eligibility for Joint Applicants: how to buy a bigger house

This article shows you an easy way to calculate how big a house you can buy based on your family’s combined monthly salary.

Home Loan Rate Hiked? How Much Prepayment should you make to Keep EMI and Tenor Same?

Home loan rate hike? You can prepay to keep EMI and tenor same. This post shows how.

How paying a small fee to your bank can save you lakhs in home-loan interest?

This article shows how paying a small fee to your bank to reduce your home loan rate can save you lakhs in interest over the life of your loan.

What benefit do you get if you make a one-time prepayment to your home loan?

This article shows you the benefits due to interest saving when you make a part-payment to your home loan. Your loan duration also reduces due to the pre-payment.

How much EMI do I have to pay for my home loan?

This article shows a handy ready reckoner for home loan EMI amounts for all tenures and interest rates along with the amount of principal and interest to be paid.

Should you prepay your home loan at the beginning or at the end of the tenure?

This article helps you decide when to prepay your home loan - at the beginning, middle or end of the total loan period.

What should you do when your home loan interest rates go up?

This post discusses managing when interest rates go up increasing your home loan EMI.

📚 Topics covered:

How does a home loan work in general?
Overdraft home loan
OD loan Terminologies
Nuances if your loan is partially disbursed
Tax benefits on OD Loan
Using the OD loan smartly

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 installments, 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 that is offered against collateral like FD (very typical), home or other assets. The key feature of an 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 an 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

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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 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 the 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.

Also read
Portfolio rebalancing during goal-based investing: why, when and how?

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 the 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 that 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 an 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 an 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 that 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, annually or once every 2 to 3 years. You could park the sinking fund in the OD account and fund your periodic expenses from there.

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 to 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.

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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