et's face it, we all loved top-ups to our ice creams as kids (I still do!).
The nuts, cherries, gooey chocolate sauce... yum!
Well guess what? Your bankers offering you the same now. Albeit in a different form: the home loan.
Yup, the boring home loan. You can great a topping, in the form of incremental loans or what are commonly known as top-up loans.
Top-up? What's that?
Read on only if you have a home loan. Let's say you are repaying your home loan.
You can get an additional loan at the current rack rates of the home finance company. The rack rate is the one fixed by the home finance company and declared to the public.
Generally, home loans are given below the rack rate. So if the rack rate is 9%, they will offer you a loan at a discount for 8.25%. But top-up loans are given at the rack rate.
The top-up loans work on a very simple premise: as you pay your home loan, your loan outstanding (what you owe the home finance company) decreases.
This, in turn, makes you eligible for more money. Cool, isn't it?
Can I take one now?
Not so soon. Each lender has its own criteria of what to expect from you.
- Some insist you should have serviced (begun repayment) the home loan for a particular period of time. HDFC asks for at least one year. ICICI Bank exercises its discretion and this is not compulsory.
- You should have an excellent repayment record (no bounced cheques).
The top-up amount that you get will depend on three factors:
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Your loan outstandings (how much of the home loan you still have to repay).
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Your property value (what is the current market value of your home for which you took the loan).
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Your repayment capacity (earning and savings).
The home loan outstanding and the top-up together cannot exceed 70% of the market value of your property. Added to this, there is a maximum cap, depending on the home finance company. No amount is given above this.
Let's talk figuresDon't fret. Your lender uses fifth grade math. No rocket science here to determine the amount available for your top-up loan.
Step 1: The lender will compute the current market value of your home.
Step 2: He will multiply the above figure by 0.7.
Step 3: From the above, he will minus your existing home loan dues.
Let's say you had taken a home loan of Rs 10 lakh for 20 years. At the end of the fifth year, your principal is now down to Rs 8.87 lakh (assuming a rate of 9% per annum).
But lucky you, property prices in your area have gone up and your haven is now worth Rs 20 lakh.
Now, let's calculate your eligibility for the top-up.
Step 1: Rs 20,00,000
Step 2: 20,00,000 x 0.7 = Rs 14,00,000
Step 3: 14,00,000 8,87,000 = Rs 5.13 lakh.
There you have it. Rs 5.13 lakh will be available for a top-up loan.
WAIT: Before you run out and book the Honda CRV, lenders have caps.
So you get Rs 5.13 lakh or the maximum cap which, in HDFC's case, is Rs 3 lakh.
You get the lesser amount, which is still substantial!
ICICI Bank norms state that the home loan + top-up loan must not exceed 85% of the market value as assessed by ICICI Bank and capped to 20% of the loan outstanding.
So Rs 8,87,000 (home loan) + Rs 5,13,000 (current top-up amount) = Rs 14,00,000.
This amount must not be 85% more than the current market value of the property (Rs 20 lakh). In this case, the top-up amount is just 70% of the current market value of the property.
What about security?
What about it? Your banker already has the security. Remember, your home is actually theirs!
When you raised the debt, you voluntarily pledged the house by signing legal documents. The pledge ends only when your debt is over (entire loan repaid). So now with an additional loan, they will just extend the pledge to cover the increased amount.
Do remember that the pledge basically means that if you do not service the payments on the loan in a timely fashion, you may lose your rights to ownership!
The best part: What can I do with the money?
Anything you please! But be sensible.
Use it to pay back a student loan or for some tuition fees like the CFA, maybe even unforeseen medical expenses. If you find the interest rate cheaper than what is being offered on a car loan, take this one instead.
Is your credit car bill getting out of hand? You pay back only the minimum and carry forward the rest (at around 2.5% per month!). Then take a top-up to square that one out.
Don't use the money for speculation in the stock market. You could lose it all along with your house. Neither should you consider this option to fund some frivolous and impulsive purchase.
Don't even think about it as seed money to start your mushroom farm. No business idea should be funded on the spur of the moment by pledging your home!
Smart cookie you may be, but go easy on creativity. You cannot use the top-up to pay back your earlier loan from the same organisation (the one you had taken 6 years ago at a double digit rate!).
Lenders are smart, too. After all, they initiated the lending, remember!
They have caveats that in the first year of availing the top-up. Any prepayments made towards your home loan (partial or full) will be adjusted towards only your top up loan! So your housing loan stays put for that year!
Let's say you took a top-up of Rs 3 lakh (remember our previous example?).
The rate of interest today is 8.5%, and you have a loan outstanding of Rs 8.87 lakh, which you are servicing at 9%.
Logic says pay off that horribly expensive home loan. Unfortunately, your lender does not agree with your logic.
So, in the first year, let's say you make a prepayment of Rs 3 lakh. That goes toward pre-paying your top up.
So all you are left with at the end of your ingenuinity is the home loan still at 9%.
Don't get too eager
While you may end up getting a substantial amount at a great rate with no tedious documentation, be cautious. You will be able to repay the loan for the same tenure as your home loan.
Just remember: you are raising a second debt against your home, so don't approach the same with gay abandon and become a chronic debt raiser.
Financing all your dreams at a cost can sometimes cause you to go way beyond your repayment ability and land you in a very messy soup.
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Illustration: Dominic Xavier
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