What is a dropline overdraft and how it works

A dropline overdraft is a flexible credit facility provided by banks and NBFCs. It allows borrowers to withdraw funds up to a pre-set limit. Unlike regular overdrafts, the limit of a dropline overdraft reduces over time until it reaches zero.

This facility is useful for businesses and individuals who need short-term working capital or funds for operational expenses. The repayment is more flexible than traditional loans, making it suitable for businesses with fluctuating cash flow.

What is a dropline overdraft

A dropline overdraft is a type of credit facility where the borrowing limit reduces gradually over a fixed tenure. Borrowers can withdraw funds within the available limit and pay interest only on the amount utilised. The facility is often secured against collateral like property, fixed deposits, or other financial assets.

For instance, if a borrower has a dropline overdraft limit of ₹10 Lakhs for a tenure of 5 years, the borrowing limit will reduce each month or quarter. By the end of the tenure, the limit becomes zero.

This gradual reduction ensures that borrowers repay the borrowed amount in instalments, unlike traditional overdrafts where the limit remains constant.

How does a dropline overdraft work

The working of a dropline overdraft is different from regular loans or standard overdrafts. Here is a simple explanation of how it works:

• The lender sanctions a fixed borrowing limit based on the borrower’s eligibility and collateral value
• The borrowing limit reduces periodically, such as monthly, quarterly, or annually, as per the agreed terms
• Interest is charged only on the amount withdrawn, not on the total borrowing limit
• Borrowers can withdraw funds within the available limit and repay them as needed
• The outstanding balance must be repaid before the limit reaches zero at the end of the tenure

Key features of a dropline overdraft

A dropline overdraft comes with several features that make it different from other types of credit facilities.

• The credit limit decreases periodically, unlike a standard overdraft where the limit remains fixed.
• This facility is often secured against assets like property, fixed deposits, or other financial securities.
• Interest is charged only on the funds actually used, not on the total credit limit.
• The limit is linked to the tenure. If the tenure is 3 years, the limit reduces each month or quarter so that it reaches zero at the end of 3 years.
• Borrowers can withdraw and repay funds multiple times within the available limit.

Benefits of a dropline overdraft

A dropline overdraft could provide several advantages for businesses and individuals. Here are some key benefits:

• Borrowers can withdraw funds as needed and repay them when funds are available
• Interest is charged only on the amount withdrawn, reducing overall borrowing costs
• The reducing credit limit ensures borrowers repay a portion of the loan regularly
• Borrowers can choose flexible tenures ranging from 1 to 10 years as per their preference
• There are no fixed EMIs, and borrowers can repay at their convenience within the tenure

Eligibility for a dropline overdraft

Eligibility for a dropline overdraft is determined by factors such as the borrower’s credit score, business turnover, and collateral value. Lenders evaluate these aspects before approving the facility. The key eligibility criteria are as follows:

Business vintage

Lenders may require the business to be operational for a minimum of 1 to 3 years. This assures lenders of the business's stability and ability to generate revenue.

Collateral

Borrowers must pledge assets such as property, fixed deposits, or other financial securities as collateral. This reduces the lender's risk and increases the chances of approval.

Credit score

A strong credit score boosts the borrower’s chances of getting the facility approved. It reflects the borrower’s creditworthiness and past repayment behaviour.

Repayment capacity

Lenders assess the borrower’s income or cash flow to ensure they can repay the borrowed amount. This helps lenders determine the borrower’s ability to meet repayment obligations.

When should you use a dropline overdraft

A dropline overdraft is suitable for businesses and individuals who need funds for the following purposes:

Working capital

It helps manage day-to-day expenses like supplier payments, wages, and operational costs. This ensures smooth business operations without cash flow disruptions.

Short-term business expenses

It provides funds for seasonal expenses, raw material purchases, or marketing campaigns. This allows businesses to seize short-term opportunities without financial strain.

Project-based funding

It supports projects with staggered payments spread over a fixed period. Businesses can withdraw funds as needed and repay them as project payments are received.

Conclusion

A dropline overdraft offers flexible credit with a reducing limit, allowing businesses to withdraw funds as needed. Interest is charged only on the utilised amount, making it a cost-effective option. Its flexible repayment structure suits businesses with fluctuating cash flow. Tools like a business loan eligibility calculator help borrowers assess their eligibility and plan repayments. For those seeking short-term credit with repayment flexibility, a dropline overdraft could be a practical choice. Visit bank or NBFC websites for more details.