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Recent media reports suggest that the Reserve Bank of India is closely monitoring top-up home loans. These are supplementary loans granted to existing home loan borrowers. Top-up loans function in the same manner as personal loans. Since lenders cannot oversee their use, borrowers use them for any purpose they like. The concern for the regulator is that lenders may be prompting borrowers to take on this debt. Excessive debt burden could lead to a surge in default rates, which would jeopardise the stability of the financial sector.
How does it work?
This loan is versatile and can be used for various purposes including home renovations, financing a child’s education, or managing a medical crisis.
“The loan amount can go up to the difference between the originally sanctioned home loan amount and the current outstanding principal,” says Adil Shetty, chief executive officer (CEO), Bankbazaar.com. For example, if you initially borrowed Rs 30 lakh and have since repaid Rs 5 lakh, your outstanding balance is Rs 25 lakh. You would be eligible to receive a top-up loan of up to Rs 5 lakh.
The interest rate for a top-up home loan typically mirrors that of the underlying home loan. “Some lenders could charge a markup of 100 to 200 basis points (1-2 percentage points) above the home loan rate,” says Abhishek Kumar, a Sebi-registered investment advisor (RIA) and founder of SahajMoney.
The tenure of the top-up loan cannot go beyond the remaining period of the initial home loan. “Most lenders cap the tenure of their top-up home loans at 15 years,” says Ratan Chaudhary, head of home loans, Paisabazaar.
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Inexpensive debt
Since these are secured loans, the interest rates on top-up home loans are lower than on unsecured loans such as personal loans or credit cards. “This makes top-up home loans one of the cheapest borrowing options for existing home loan borrowers,” says Chaudhary.
The processing of a top-up loan is easy. “As you get a top-up on an existing home loan, there is little to no additional paperwork because all the checks have already been done,” says Shetty.
Chaudhary says some lenders have started offering pre-approved instant top-up home loans, where the loan amount is disbursed within the same day of making the loan application.
“These loans also offer tax benefits if the proceeds are used for home renovation,” says Kumar.
Longer tenure, higher interest cost
One downside of these loans can arise if the borrower repays the top-up loan over an extended period. For instance, if you need Rs 5 lakh, you could take a personal loan at the rate of, say, 15 per cent and repay it within two years. Alternatively, you can opt for a top-up loan on your existing home loan for the same amount with an interest rate of, say, 8 or 9 per cent and repay it over 15 years. “You will end up paying significantly more in total interest in case of the top-up home loan,” says Shetty.
Chaudhary warns that some lenders take two to three weeks to disburse top-up home loans from the date of the loan application.
Using these loans, borrowers often overspend on home improvements, or worse, on exotic holidays. Some even use the money to do day trading. “Many of them ultimately find themselves in a debt trap,” says Kumar.
Avoid overleveraging
If you urgently need funds and have an ongoing home loan, you may consider a top-up loan. “But prepay it as fast as possible,” says Shetty.
Kumar recommends establishing a realistic budget for home improvements and adhering strictly to it. He cautions that this loan should not be used to finance exotic holidays or extravagant purchases. “Limit your total EMI outgo at not more than 35 per cent of your monthly take-home income,” he adds.
Other loans you may consider
If you do not have an active home loan, consider other forms of secured loans such as a loan against a fixed deposit or a loan against gold. Only if you lack an asset to pledge should you opt for a personal loan, which typically carries a higher interest cost.
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