When is it a good idea to take a top up home loan?

Top-up on home loan is a lesser known way to fund critical financial requirements at a lower cost as compared to unsecured options.

Many of us are well versed with home, car and personal loans. However, very few of us know about “top-up” on home loans. In many ways, a top-up loan is a far more cost effective option and also qualifies for tax breaks.

Meaning and features

Let us assume you have taken a home loan & have used it to fund your house purchase. After some years, as you keep paying the loan EMIs, the outstanding principal of your loan decreases. Simultaneously, your salary increases, which improves your loan eligibility. At this point, if you need funds for any purpose, be it renovation or any personal use such as your child’s higher education or even a medical emergency, the first impulse is to go for a personal or a credit card loan which, being an unsecured loan, carries a very high interest rate.

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A lesser known & better option here is to approach your existing home loan provider and ask for a top up loan. Since a top loan is issued on the same security or ‘collateral’ as applied to your earlier home loan, i.e. your house, it qualifies as a “secured” loan and comes at a lower interest rate which in most of the cases, would match the home loan interest rate.

When you are considering an additional loan of, say, Rs 25 lakh, it is worth prepaying some of your smaller loans like personal loan and consolidating your borrowing against your property. This has a couple of advantages:

• Home loans or loans against property are long-tenure loans of 15-20 years, so the EMI per lakh of borrowing is the lowest compared to an auto or personal loan, which is of 4-5-year duration.
• Also, banks consider loans secured against property to be a safer bet and offer the lowest interest rate for such loans compared to other types of loans.

Thus, consolidating your borrowings against your property is a good option as the EMI burden and interest payable can be reduced significantly.

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Tax deduction for top-up loan

The provisions on tax deductions for a top up loan are very different from a regular home loan, as explained below:

1. On the interest portion of EMI:

You can claim the tax deduction only and only if the funds are used for repair or renewal of the flat, and money spent on any other end use will not qualify for tax deduction. Amount of tax deduction will depend on the type of property as follows:

• Self-occupied property: Limited to Rs. 30,000.
• Let-out/deemed to be let out property: No such maximum limit.

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1. On principal portion of EMI:

It does not qualify for a deduction, irrespective of its end use.

Should you opt for a top-up loan?

• If the RBI reduces the repo rate (the rate at which it lends money to commercial banks), you may have the opportunity to re-negotiate your borrowing rates with your bank, or consider switching to another lender. However, don’t do this if only a few years of loan repayment remain. If this doesn’t work out, go for a top-up loan.
• Since a top-up loan is treated as a fresh loan & involves property valuation and credit assessment, it involves considerable paperwork and processing fee, as compared to a personal loan.
• As discussed above, tax breaks for a top-up loan are not significant enough as compared to a proper home loan.
• Interest paid on top-up loan is effectively a cost, and also creates a fixed monthly obligation in the form of an additional EMI & also may require you to increase your life insurance cover and contingency fund.

Related: Did you know you can avail a loan against your insurance policy?

Conclusion

In the backdrop of the above, your first aim should be to plan your finances in such a way that the requirement of a top up loan does not arise in the first place. However, in a case where requirement is critical & existing investments are not sufficient to fund it, a top up loan is any day preferable over a personal or a credit card loan, simply because of the low interest rates and possible tax breaks that can further reduce the effective cost of the loan.