A Loan against Property can take two forms — A Term Loan or an Overdraft Facility.
What Is the Difference?
In a term loan, the entire amount will be disbursed upfront. You will pay EMIs on the loan for the duration of the loan. You will have to pay interest on the disbursed amount even if you do not use the amount and the money lies in your bank account.
In an overdraft facility, you do not have to withdraw the entire amount upfront. You can withdraw the amounts as per your wish. You pay interest only on the withdrawn amount. You can repay the withdrawn amount and withdraw it again. ICICI Bank offers Home Loan Overdraft facility to salaried customers.
Simply, by looking at the nature of the facilities, you can see that these facilities will be useful in different cases.
Which Option Is Better?
Your choice will depend on your needs.
If you need a lumpsum amount or if the requirement of funds is spread over a short period of time, a term loan against property is a better choice. Let’s say you need to provide capital for your or your son’s business venture. Or you want to take a loan to fund your daughter’s education or marriage. Or to fund an expensive medical treatment of a family member. Another way to look at this is — If you can’t repay this amount in a short time, it is better to go for a term loan.
If your need for the funds is relatively short term, unpredictable (about the quantum and the timing of requirement), an overdraft is likely to be a better choice. For instance, you are aware of an impending expense (say an expensive medical surgery) for a family member. You are not sure if and by how much you will fall short. You want the overdraft facility to be the backup option. As you can see, there is a level of unpredictability in both the quantum of funds you will need and the timing of such a need.
Many of us may want an overdraft like facility to manage short term cashflow mismatches. However, it may not really be wise to go for Overdraft (or even term loan) against your property for small amounts. Since your property must be mortgaged, you wouldn’t want to spend the time and money for small amounts. A credit card or a personal loan may serve your purpose better for smaller amounts.
If you are taking loan for your business, a term loan is a better choice if you want to purchase/create fixed assets like building, machinery etc. On the other hand, an overdraft facility is a better choice if you want to finance your working capital needs.
The renewal of overdraft facility happens every year (or a regular period). This means the bank makes a credit decision at each renewal. And this poses some risk for you. If, for any reason, the bank refuses to renew the facility, you may face problems. You will need to pay them back the entire amount at a very short notice. If you can’t do that, the bank will start the recovery process.
This may not be a big problem since the bank has property as the security and adequate security cover. Renewal can be a tricky when the bank has charge merely on the current assets of the company. In any case, if your facility is not renewed for any reason, you must pay back the amount. You must keep this in mind if you are signing up for an overdraft facility. You must have the ability to close the facility, if you are forced to.
A term loan is a long-term facility. There is no concept of renewal. The bank cannot come and demand repayment of funds at a short notice.
Fees and Interest Rates
In an overdraft, your facility will be renewed on a regular basis, say on a yearly basis. Every renewal will entail processing fee. The bank can also charge a commitment fee (or include it within the processing fee) on the unutilised portion of the overdraft facility. This adds to your costs.
In the case of a term loan, you have to pay the processing fee just once.
The bank will likely charge a higher rate of interest in the Overdraft for the flexibility in withdrawals and repayments.
Everything else being the same, an overdraft facility will be expensive than the term loan.
At the same, on overdraft facility, you pay interest only on the withdrawn amount (and for the period that you withdrew it). In term loans, you wouldn’t get this benefit. In a few types of term loans, disbursements are linked to events or milestones. For instance, in construction linked home loans, the disbursements are made based on construction milestones achieved. In case of education loans, the disbursements are made as per the fee schedule. On the other hand, in case of personal loans, you can’t ask the bank to disburse as per your requirement. The bank will disburse once. If you want more money, you need to apply for another loan. As I understand, the Loan against property (LAP) falls under the second category.
All banks, HFCs and NBFCs will provide term loans against property. However, that is not the case for overdraft facility against Property. As I understand, even the State Bank of India does not offer Overdraft in its LAP offerings. Therefore, if you are looking for an overdraft facility, your options may be limited.
As I understand, housing finance companies (HFCs) or non-banking finance companies (NBFCs) cannot offer overdraft facility because there is no concept of savings/current/cash credit account there. Therefore, if you are looking for an overdraft facility, you will have to reach out to a bank.
Which one would you pick? A Term Loan or an Overdraft facility?