It is not uncommon to get a call from lending institutions offering a flexi loan, also known as a dropline overdraft facility. However, not many are aware of how this loan works and whether it is a better option than the conventional overdraft facility or a personal loan. We tell you how it works and whether you should go for such a loan when you have other options.

WHAT IS A DROPLINE OVERDRAFT AND HOW DOES IT WORK?

As the name suggests, it is an overdraft facility in which the total credit limit offered at the beginning comes down gradually and it finally becomes zero at the end of the specified tenure.

“In the dropline facility, the principal amount diminishes periodically, varying from month to month, quarter to quarter, semi-annually or annually, contingent upon the financial institution's policies,” says Adhil Shetty, CEO, Bankbazaar.com.

For instance, if you take a dropline overdraft facility with an initial limit of Rs 6 lakh for 3 years with an annual dropline, you will be able to withdraw up to Rs 6 lakh any time or many times before the year ends. However, the limit will be reduced to Rs 4 lakh after the first year; to Rs 2 lakh after 2 years; and it will eventually come down to zero after 3 years.

A combination of conventional overdraft and dropline overdraft is offered in the form of a hybrid product. “There's also a hybrid flexi loan option where, for the initial two years, customers need to pay only interest. After 24 months, the loan converts into a dropline flexi for the remaining tenure. The costs remain the same for both dropline and normal flexi loans,” says Rishi Mehra, CEO of Wishfin.com.

HOW DOES A FLEXI LOAN DIFFER FROM A PERSONAL LOAN AND A NORMAL OVERDRAFT FACILITY?

A personal loan typically comes in the form of a term loan with EMI as a repayment option. “A personal loan is a lump-sum loan disbursed by a bank or financial institution for a specific purpose. The borrower receives the entire loan amount upfront and repays it in installments,” says Shetty.

An overdraft facility gives the flexibility to withdraw the money as and when you wish and repay it anytime at your convenience. “Overdraft facility is a revolving credit facility linked to a bank account. The account holder can withdraw more money than the available balance, up to a pre-approved limit,” says Shetty. The interest is charged only on the outstanding amount that you have taken out and not on the total sanctioned limit. However, the sanctioned limit remains unchanged till the end of the tenure or until the annual revision. “In a traditional overdraft facility, the customer can utilise the same limit until the end of the tenure,” says Mehra.

While the repayment flexibility and interest charging mechanism remains the same with flexi loan or dropline overdraft facility, the limit does not remain constant during the tenure. The limit reduction mechanism may vary from lender to lender as many lenders offer annual reductions.

FLEXI LOANS CAN BOTH BE SECURED CREDIT WITH COLLATERAL AND UNSECURED CREDIT

Dropline overdraft facility is offered both as secured and unsecured credit. “The dropline overdraft facility falls within the secured and unsecured loan categories, available for a predetermined duration. Under the secured option, collateral such as FDs, mutual funds, or property can be utilized, resulting in a lower interest rate. Conversely, the unsecured alternative, akin to a personal loan, may incur higher interest rates,” says Shetty.

However, in a secured option, the borrower is able to use the collateralized asset. “Despite this, the borrower maintains ownership rights to the collateralized property, retaining the ability to utilize it for residential or commercial purposes,” says Shetty.

While self-employed people usually get the secured option, salaried people typically get the option of unsecured dropline overdraft as they do not need to give any asset as collateral.

WHAT ARE THE CHARGES FOR A DROPLINE OVERDRAFT FACILITY?

There is a cost associated with the flexibility of the repayment offered by a normal overdraft facility where you have to typically pay an annual maintenance charge. “Unlike some financial products, there is no annual maintenance charge (AMC) associated with dropline overdraft. The monthly interest is charged on the outstanding balance. However, it may vary depending on the institutions and terms and conditions of the borrowing,” says Shetty.

The interest rate and the charges that you will be offered will depend on many factors. “The cost may vary from one financial institution to another depending on the credit score and profile of the borrower and the amount he needs. Your creditworthiness is what is crucial in this case,” says Shetty.

In terms of total cost, flexi loans are comparable to personal loans or unsecured overdrafts. “The charges for a dropline overdraft facility typically range between 1.5% and 3%. These charges encompass various components including processing fees, insurance, flexi fee (if applicable, specifically with Bajaj), and account opening fees (for Kotak Bank),” says Rishi Mehra, CEO, Wishfin.com.

If you are a salaried person, which option will work best for you? According to Mehra, the cost-effective option for a salaried person typically depends on the financial circumstances and requirements. Term loans generally offer lower rates of interest (ROI) and processing fees (PF), with no AMC charges. An overdraft can be beneficial for individuals with liquidity who anticipate periodic inflows, such as incentives or bonuses, as they can make part payments as and when they have surplus funds. Dropline overdraft might be suitable for individuals who frequently require funding and prefer the flexibility of a revolving credit facility.

FLEXI LOAN VS OVERDRAFT VS PERSONAL LOAN: WHICH OPTION TO CHOOSE WHEN YOU NEED FUNDS?

The loan amount requirement and the repayment horizon should decide which option is the best one. “Overdraft facility is typically used for short-term and temporary financial needs. It provides flexibility for managing cash flow fluctuations and unexpected expenses. A personal loan should be used for specific purposes such as home renovation, medical expenses, travel or debt consolidation,” says Shetty.

According to Mehra, a term loan is optimal for individuals seeking lower interest rates and fixed repayment schedules, particularly if they lack immediate liquidity. An overdraft is ideal for those with intermittent cash flows who can make use of the revolving credit facility as and when needed. While dropline overdraft is suited for individuals who anticipate regular borrowing needs and prefer the flexibility of a revolving credit line.