Top-up loans come really cheap

CREDIT NOTES

Apart from the lure of rock-bottom interest rates, promise of lowest equated monthly instalment, choice of fixed/ floating rates, refinancing of existing loans and what have you, housing finance entities, during the last one year or so, have been offering an innovation called top-up loans.

So, what is a top-up loan? It is a personal loan masquerading as a housing loan since there is no restriction on end use. It allows a customer, already having a mortgage, to get an additional loan from his bank/ housing finance company.

As the loan is secured against the house, the interest rate on a top-up is either the same as on the existing home loan or will cost at the most about 100 basis points more. The tenor of this additional loan could stretch up to the length of the home loan.

A top-up allows home owners to unlock investment in their home without having to sell it. The money can be used for renovation/ home improvement, purchase furniture, higher education "" maybe for holidaying too.

How does it work?
Vivek Tripathi, a 40-year old senior management-grade official with a public sector undertaking, had taken a Rs 10 lakh, 15-year floating rate loan from a private sector bank some years back at 9.50 per cent interest. Right now, his loan outstanding stands at Rs 9.5 lakh.

With interest rates moving southwards during the last two years, the interest burden on the outstanding has come down to eight per cent. Tripathi's equity contribution to the house, which cost him Rs 12 lakh, is Rs 2 lakh.

Tripathi has been diligent in paying his dues. The bank takes notice of his clean credit record and offers him a top-up, equivalent to the amount he has repaid (Rs 50,000) on his home loan at eight per cent for a tenor not exceeding the residual maturity of the home loan. He is also offered an alternative, whereby he could avail of a higher top-up limit.

Suppose, during the two-year period, the valuation of his house increases by Rs 1 lakh to Rs 13 lakh. Taking this higher valuation of the house into consideration, the bank may offer him Rs 1 lakh (the repaid amount of Rs 50,000 + up to 50 per cent of the amount by which the market value of the house has increased "" i.e., Rs 50,000) as top-up.

In order to poach business, banks use the combination of refinance at a lower rate and a top-up to win customers from rivals. If a customer does not switch (or transfer his balance) purely on the basis of say a 50 basis points reduction in the interest rate, the competing housing finance firm may offer him a lollipop in the form of a top-up.

HDFC, the housing finance sector leader, offers a maximum loan of 70 per cent of the market value of the property less the outstanding loan as the top-up.

For example, if the market value of a property is Rs 8 lakh, 70 per cent of this will be Rs 5.60 lakh. Now, if the outstanding loan is Rs 3 lakh, it means the top-up will be Rs 2.60 lakh.

The top-up offered is dictated by the ability of the customer to repay. As documents pertaining to the home loan/ title deed are already in the bank's custody, all that a customer is asked for is his latest salary statement. It should be borne in mind that Income Tax (Section 24 and Section 88) benefits, as available to home loans, is not available on top-ups.

TOPPING IT ALL:
A top-up loan is nothing but a personal loan disguised as a housing loan since there is no end-use restriction. The advantage for the loanee is the interest rate is around 10-15 per cent less"" YES, 10-15 PER CENT LESS "" than a personal loan.