How You Can Use Home Loan Overdraft Facility Smartly?

This home loan variant may go by any nomenclature, but the concept remains the same.

• You take a home loan.
• You have an “Excess Account” where you can keep your excess funds. You can also call it “Overdraft Account.”
• In the next month, interest is calculated only on the (Home loan outstanding – Balance in the Excess account).
• Since the EMI is constant and the interest to be paid is lower than as per the amortization schedule, a bigger portion can go towards principal repayment. Here, the loan products can take two approaches.
  • Reduce the principal repayment as mentioned in the amortization schedule only. Any excess moves to the “Excess Account” OR
  • Outstanding principal goes down by more than the contracted amount.

Let’s understand this with the help of an example.

You have a loan of Rs 50 lacs for 15 years (outstanding tenure). Interest rate is 9% p.a. EMI is, say, Rs 50,313.

Case 1: Regular Home Loan Payment
Month	O/S Balance at the start of month	EMI	Interest	Principal Repayment	O/S Balance at the end of month
1	5,000,000	50,713	37,500	13,213	4,986,787
2	4,986,787	50,713	37,401	13,312	4,973,474
3	4,973,474	50,713	37,301	13,412	4,960,062
4	4,960,062	50,713	37,200	13,513	4,946,549
5	4,946,549	50,713	37,099	13,614	4,932,935
6	4,932,935	50,713	36,997	13,716	4,919,219
7	4,919,219	50,713	36,894	13,819	4,905,399
8	4,905,399	50,713	36,790	13,923	4,891,477
9	4,891,477	50,713	36,686	14,027	4,877,449
10	4,877,449	50,713	36,581	14,132	4,863,317
11	4,863,317	50,713	36,475	14,238	4,849,078
12	4,849,078	50,713	36,368	14,345	4,834,733

 

Case 2: Principal Repayment does not change from the original amortisation schedule
Month	O/S Balance at the start of month	Excess Account Balance at the start of month	EMI	Interest	Principal Repayment	O/S Balance at the end of month	Excess Account Balance at the end of the month
1	5,000,000	2,000,000	50,713	22,500	13,213	4,986,787	2,015,000
2	4,986,787	2,015,000	50,713	22,288	13,312	4,973,474	2,030,113
3	4,973,474	2,030,113	50,713	22,075	13,412	4,960,062	2,045,338
4	4,960,062	2,045,338	50,713	21,860	13,513	4,946,549	2,060,678
5	4,946,549	2,060,678	50,713	21,644	13,614	4,932,935	2,076,133
6	4,932,935	2,076,133	50,713	21,426	13,716	4,919,219	2,091,704
7	4,919,219	2,091,704	50,713	21,206	13,819	4,905,399	2,107,392
8	4,905,399	2,107,392	50,713	20,985	13,923	4,891,477	2,123,198
9	4,891,477	2,123,198	50,713	20,762	14,027	4,877,449	2,139,122
10	4,877,449	2,139,122	50,713	20,537	14,132	4,863,317	2,155,165
11	4,863,317	2,155,165	50,713	20,311	14,238	4,849,078	2,171,329
12	4,849,078	2,171,329	50,713	20,083	14,345	4,834,733	2,187,614

You credit Rs 20 lacs to the Excess Account on Day 1. 

You can see the principal repayment remains as per the amortization schedule. And any interest savings are credited to the Excess Account. At the end of 12 months, home loan outstanding is same at 48.34 lacs and the Excess Account balance has grown to Rs 21.87 lacs.

And how you have earned?

Exactly 9% p.a. The cost of loan.

Rs 20 lacs * (1+9%/12) ^ 12 = Rs 21.87 lacs

You have saved 1.87 lacs in interest in 12 months. Your Excess balance account grew by 1.87 lacs in 12 months.

Interest saved is interest earned.

Note this growth in Excess Account balance is NOT taxable. It is just your money that was not used for interest or principal repayment and flowed into the Excess Account. Hence, no question of taxes. 

Case 3: Principal Repayment goes up
Month	O/S Balance at the start of month	Excess Account Balance at the start of month	EMI	Interest	Principal Repayment	O/S Balance at the end of month	Excess Account Balance at the end of the month
1	5,000,000	2,000,000	50,713	22,500	28,213	4,971,787	2,000,000
2	4,971,787	2,000,000	50,713	22,288	28,425	4,943,362	2,000,000
3	4,943,362	2,000,000	50,713	22,075	28,638	4,914,724	2,000,000
4	4,914,724	2,000,000	50,713	21,860	28,853	4,885,871	2,000,000
5	4,885,871	2,000,000	50,713	21,644	29,069	4,856,801	2,000,000
6	4,856,801	2,000,000	50,713	21,426	29,287	4,827,514	2,000,000
7	4,827,514	2,000,000	50,713	21,206	29,507	4,798,007	2,000,000
8	4,798,007	2,000,000	50,713	20,985	29,728	4,768,279	2,000,000
9	4,768,279	2,000,000	50,713	20,762	29,951	4,738,328	2,000,000
10	4,738,328	2,000,000	50,713	20,537	30,176	4,708,152	2,000,000
11	4,708,152	2,000,000	50,713	20,311	30,402	4,677,750	2,000,000
12	4,677,750	2,000,000	50,713	20,083	30,630	4,647,119	2,000,000

Again, in this case, you fund the Excess (Overdraft) account with Rs 20 lacs. 

But, in this case, the interest savings get utilized towards principal repayment.

At the end of the 12 months, the loan outstanding is only Rs 46.47 lacs. In the previous 2 cases, it was 48.34 lacs. How much extra loan has been prepaid?

Rs 48.34 – Rs 46.47 = Rs 1.87 lacs

And the Excess Account balance stays constant at 20 lacs.

Frankly, there is no difference between Case 2 and Case 3.  In case 2, you could have repaid the loan by 1.87 lacs (draw money from excess account to prepay) at the end of 12 months.

How Are Home Overdraft Loans Useful?

#1 Flexibility and Liquidity

You can take out money whenever you want. No restriction.

You can deposit whenever you want.

Hence, whenever you have excess funds for a few days, weeks, or months, you can simply keep the amount in the Excess Account. That will help you save interest on the home loan. And interest saved is interest earned.

This Excess Account (overdraft account) could be a good place for your short-term savings and even an emergency fund.

#2 Decent Tax-Free Returns

You often see home loans at 9% p.a. Do you have a bank fixed deposit offering 9% p.a.?

OR how often have you seen the banks offering the same interest rate on their bank FDs as their home loans?

You won’t.

Because the banks won’t survive if they do that.

But that’s exactly what you get on Balance in your excess account (Overdraft account). And too tax-free.

Remember FD interest is taxed at your slab rate. The increase in Excess Account balance is not taxed (in Case 2. In Case 3, there is no growth in Excess Account Balance).

Things to Keep in Mind

1. Home Loans with Overdraft facility come at a slightly higher cost compared to  regular home loans. The interest rate may be higher by about 25 to 50 basis points. Hence, this flexibility comes at a cost. While deciding between regular and overdraft cost, you might compare this extra interest cost against the flexibility that overdraft home loans offer. Personally, I value flexibility quite a bit.
2. With home overdraft loans, you earn interest by saving interest on home loan. Hence, there is no benefit if the Excess (Overdraft) account balance exceeds the outstanding home loan amount. Because, when this happens, your net loan is zero. Zero loan means zero interest saving. For instance, if the home loan outstanding is Rs 20 lacs and the Excess account is Rs 30 lacs, you can save interest on only Rs 20 lacs. The extra 10 lacs does not save any interest and hence does not earn any interest either.