MAKING SENSE OF OVERDRAFT FACILITIES

Mr Peter Tan wanted to buy a new car as he often had to make sales calls to his clients. He decided to use his overdraft (OD) facility to finance the new car. He thought this was a good decision, as unlike a car loan, an overdraft facility did not require him to make monthly instalment payments. He chose to service the monthly interest only.

Three years later, Mr Tan decided to change his car to take advantage of the low COE prices. It was then that he realized that his OD for the purchase of his first car was never repaid. He had only paid the interest, and the principal amount was still outstanding. After he sold his old car, he still had to fork out extra money to repay his OD as the sales proceeds were not enough to cover the outstanding overdraft balance.

What went wrong?  Mr Tan failed to consider whether an OD facility was suitable for his purpose of buying a car. An OD should be used as a short-term (up to 12 months) standby credit facility. As Mr Tan did not intend to repay the full OD balance within a short period, the OD was not an appropriate financing instrument. You should borrow only when you need and pay only for the funds you use. Read on to find out more about OD facilities.

Q1: What is an overdraft (OD) facility and how is it different from other revolving credit facilities such as a personal credit line?

A: An OD facility is a revolving credit facility offered by banks on a current account. You can draw cheques or withdraw cash at ATMs or over-the-counter up to the credit limit approved. 

The OD limit is the maximum credit amount that you can overdraw. You pay interest only on the amount that you overdraw. Interest is calculated on daily balance and debited to the account monthly. Interest rate on an OD account is usually charged at a percentage over the bank’s prime lending rate, for example, Prime+3% per annum.

Whatever amount you repay into the OD account can be withdrawn again as long as the total outstanding amount is within the credit limit granted, hence the term “revolving credit facility”. The OD facility is a short-term facility which is usually renewable on a yearly basis and is repayable on demand by the bank at any time.

Banks also offer other forms of revolving credit facilities. These operate somewhat like OD facilities. A credit limit is granted, use of the facility is by means of cheques and interest is charged only on the amount used. However, interest on these accounts are fixed and not pegged to the bank’s prime rate. Another unique feature is that there is a minimum repayment amount each month, even if the amount used is within the credit limit. Any amount repaid can be withdrawn again as long as the total outstanding amount is within the credit limit.

Q2: What are the differences between a secured and unsecured OD?

A: An OD facility can be granted on a secured or unsecured basis. A secured OD is one where a tangible asset such as a fixed deposit, legal mortgage of a property or stocks and shares is pledged or offered as security. In the event that the bank recalls your secured OD facility and you are unable to pay, the bank has the right to dispose of your pledged assets to repay your outstanding balance. If the proceeds are insufficient to repay the outstanding balance in your account, you are still liable for the difference.

An unsecured OD facility on the other hand, is granted without any assets being offered as security. Under current laws, unsecured credit facilities can only be granted to individuals with an annual income of at least $20,000. An aggregate maximum credit limit for all unsecured credit and credit cards across all affiliated entities will be set at four times the borrower’s monthly income for individuals earning at least $30,000. For individuals with an annual income below $30,000, who are therefore not eligible for credit cards, a maximum credit limit of two times the borrower's monthly income will apply. However, these rules do not apply to unsecured education and home renovation loans. For home renovation loans, you can borrow up to six times your monthly income, subject to a maximum sum of $30,000, for a period of up to five years. For education loans, the maximum loan amount and minimum income are determined by the banks based on their internal guidelines. In the event that the bank recalls your unsecured OD facility and you are unable to pay, the bank can institute legal proceedings against you.

Q3: How does an OD compare with other avenues to borrow money?

A: An OD facility, being a revolving short-term credit facility, is not subject to any repayment as long as the amount used is within the credit limit. The OD facility however is repayable on demand by the bank at any time. On the other hand, a Term Loan is a contractual arrangement where the money owed must be fully repaid over the period of the term loan by regular installment repayments.

The main characteristics of OD facilities and Term Loans are shown below:

Q4: What are some of the charges for an OD?

A: The OD facility has various charges, but only some may be relevant to you:

Q5: Are there minimum monthly repayments for OD facilities? What happens when I fail to make a payment?

A: There are no minimum monthly repayments for an OD facility as long as the outstanding balance is within the credit limit. However, if the account goes into “excess” and the bank has approved the temporary excess, you need to repay the excess amount immediately.  If the excess is not paid after you receive a notification from the bank, the bank can recall the OD facility and require you to repay the full outstanding amount within a stipulated time. If the bank recalls your OD facility, your credit record will be adversely affected.

Q6: Are there credit limits for all OD facilities?

A: Yes. Every OD facility has an approved credit limit.

Q7: What are some of the extra facilities that come along with an OD facility?

A: As the OD facility is operated through a current account, all the services available to current account holders will be available to you. These include an ATM card, GIRO facilities, the right to implement standing orders, phone and Internet banking facilities.

Q8: What are the implications (if any) of taking up an OD facility as a joint applicant?

A: As a joint applicant of an OD facility, you and your joint applicant(s) are all liable to the bank for the outstanding loan, regardless of which applicant used the facility. The bank can choose to recover the total outstanding amount from all account holders, partial amounts from each account holder, or the total amount from any one account holder.

Q9: If I have a dispute with my bank on OD matters, whom can I approach for help?

A: If you encounter any problems with your bank, approach your bank first as they have easy access to your records. If you are dissatisfied with the bank's response, you may wish to approach the Financial Industry Dispute Resolution Centre (FIDReC) which is the independent dispute resolution center for the financial industry.

This information is provided by The Association of Banks in Singapore (ABS) as part of the MoneySENSE national financial education programme.