Top up loans have costs such as processing fee and in takeover cases foreclosure charges of previous home loan. Top up loan need not necessarily offer tax sops.
Adhil Shetty, Bankbazaar.com | Source : MoneyControl.com
Ravi, an IT professional received a call from a bank offering a home loan. When Ravi told that he already had a home loan with a different bank, the caller suggested a loan transfer to their bank, with an offer of an additional Rs 10 lakh as top up loan.
The offer seemed lucrative for Ravi who was eyeing a new sedan and was looking to fund his buy. His existing bank had offered him a car loan at an interest rate of 11.5%. Hoping to save on his interest outgo, he had approached his existing bank for a top up loan to fund his car buy, only to be offered a top up loan of Rs 5 lakh at 10.5%.
The top up loan offer from the new bank sounded attractive for Ravi, as they not only offered to takeover his existing loan at 10.25% but also offered a higher top of loan of 10 lakhs, which would be sufficient for his car purchase.
All in all, Ravi’s problems appeared to be solved. But, is it really? Let’s take a closer look.
Understanding ‘Top-up’ loans
Top up loans are offered only to existing home loan borrowers with a good repayment track record. Top up loans work on the basic principle that since you have started reducing your outstanding loan amount by repaying it, a margin money by way of a top up can be added to your loan account. The amount taken as top up loan can be used for any purpose like wedding expenses, medical expenses, car purchase, or any other.
If you are transferring your existing home loan to a new bank, they will also offer you a top up loan, provided you have a good track record with the other bank.
Now let’s run the numbers in Ravi’s case.
The math in Ravi’s case
In Ravi’s case, his existing home loan was at a fixed interest rate of 10.5%. The new bank offered him a takeover, plus a top up loan of Rs 10 lakh at 10.25%. Ravi who was in need of money didn’t think twice on hearing the offer. But, let’s do the math.
Ravi’s current principal outstanding was Rs 38 lakhs. As it was a fixed rate loan, he had to pay 2% of the outstanding as pre-closure fee, which comes to around Rs.76,000. Now, the new bank charged Ravi a processing fee of 1%, i.e., around Rs.48,000. So altogether, he paid around Rs.1.24 lakhs for the transfer.
What Ravi did not realize was that the difference in the interest rate was only marginal, i.e., 0.25%. So, the additional expense he incurred during the switching process in fact exceeded the amount he saved on interest outgo, which was around Rs. 1 lakh.
Here are few things you should know before taking up a top up loan.
A lucrative top up loan offer may lead to a bad loan take over: A top up loan offer along with a takeover may sound lucrative, but weigh the deal after calculating the possible charges associated with it.
No tax advantage: You will get a tax advantage for a top up loan only if you use the loan amount exclusively for repair, renovation and construction activity of the home. Otherwise top up loans are loans with no tax sops, unlike a home loan.
Charges for the loan: Banks charge a processing fee to facilitate top up loans. For customers who are shifting their home loans from a different bank, the processing fee is applicable for the takeover as well as the top up amount. Also, most top up loans are offered at 0.5-1.0% higher interest rates than a usual home loan.
No say in property price appreciation: Most banks offer top up loans in accordance with the amount of money which is reduced by the outstanding amount of the home loan through repayment. Even if the property price witnesses an increase in price index, the quantum of top up loan may not be increased by the bank. Many customers who wait for top up loans realize this at a later stage.
Banks have the final call: While top up loans may have their benefits and are even considered superior to personal loans, banks are the final authority in approving or rejecting any top up loan plan. Even if you receive a deal from the tele-sales person, the final call on approving your loan lies with the credit department.
The Bottom Line: Even if you may not need a loan, the prospect of an easily approved loan where the funds can be used in any way is far too alluring for many borrowers. So, if you think the persuasive telesales representative who is asking you to consider a loan takeover by offering you a top up loan is doing you a favor, ask the right questions, analyze the deal end to end, and then take a final decision.