Beware, over-leveraging with top-up home loan could cost your home

Top-up home loans are currently in the spotlight. Reserve Bank of India (RBI) Governor Shaktikanta Das recently raised concerns about the rapid growth of these loans, noting that some lenders are not adhering to regulations related to loan-to-value (LTV) ratio, risk weights, and monitoring the end use of funds.

How do these loans work?

Banks and housing finance companies offer a top-up home loan to borrowers as an additional loan on top of their existing home loan. “If a borrower has been paying EMIS regularly on a home loan for 18-24 months, they become eligible for a top-up home loan from the same lender,” says Rishi Mehra, chief executive officer (CEO), Wishfin.

 

The maximum amount offered is the difference between the originally disbursed home loan amount and the current outstanding (that is, the sum repaid).

A top-up home loan’s tenure can, in theory, extend up to the residual tenure of the home loan. “In reality, most lenders cap the tenure at 15 years,” says Ratan Chaudhary, head of home loans, Paisabazaar.

Top-up home loans are usually disbursed within two to three weeks. However, many lenders now offer instant options with same-day disbursement, though for smaller amounts.

Inexpensive, readily available

The interest rates on these loans are usually the same as on the underlying home loan (8.25 per cent onwards), or slightly higher. “Availing a top-up home loan tends to be cheaper than alternatives like a personal loan, loan against a credit card, or a gold loan,” says Chaudhary. For borrowers with a home loan, a top-up serves as a good source of funding to consolidate other higher-cost debts.

Mehra informs that obtaining these loans is easy, with minimal documentation required.

The longer tenure of these loans can also prove beneficial. “If an existing home loan borrower has a residual tenure of more than seven years, availing a top-up home loan can allow her to secure a bigger loan amount with a lower EMI than other loan alternatives,” says Chaudhary.

Keep an eye on your budget

The easy availability of these loans can lead borrowers to overspending. “The biggest risk of top-up loans is of home buyers exceeding their budget,” says Abhishek Kumar, a Sebi-registered investment advisor (RIA) and founder, SahajMoney.

Using these loans for consumption and speculative purposes can also be risky. “If the borrower cannot repay the loan due to lack of income or losses from speculative activities, they risk defaulting on it. This could lead to the bank seizing the property,” says Mehra.

Mind the end-use

Many lenders offer a top-up home loan at the time of balance transfer. “Borrowers who are unable to secure a top-up home loan from their existing lender, or are asked for a higher interest rate, may opt for a balance transfer and avail a top-up,” says Chaudhary.

After RBI’s warning, borrowers should be cautious about end usage. “Top-up loans on property are typically meant to fund home improvements. They can also be used for other purposes, such as education or medical expenses, provided this is specified at the time of borrowing,” says Adhil Shetty, CEO, Bankbazaar. Borrowers should avoid using this money for stock market speculation.

Kumar suggests having a budget for home improvements and interiors and sticking to it.

Customers seeking funds for a vacation or consumption-related purchases should avoid using a top-up loan. “Choose a loan specifically designed to fund consumption rather than put your home at risk,” says Mehra.

Stick to LTV limit, avoid long tenures

·       Take this loan only to fund mandatory expenses on interiors and home improvements

·       After RBI’s warning, don’t exceed the RBI-mandated LTV limit (75-90 per cent, depending on loan amount) on home loans

·       Limit the tenure of top-up loans to two to four years

·       Despite the lower interest rate on top-up home loans, total interest outgo will rise if you select a longer tenure