Tempted by a top up loan offer? Here’s why it may not be a bright idea

• Top-up loans are available to those who have an ongoing personal loan with the lender.
  
• Once a borrower has successfully repaid a significant portion of their existing home loan, they become eligible for a top-up loan.
  
• Taking a top-up loan means that your debt burden increases.
  

A top-up loan, as the name suggests, allows borrowers who already have an ongoing loan to access additional funds on top of their existing loan amount. This additional amount is added to the existing loan principal, extending the total borrowed amount without requiring a separate loan application process. These top-ups are available mostly for personal loans and for home loans.

Top- up personal loans

Several financial institutions offer a top-up on personal loans to existing borrowers who have a good repayment track record. “This allows such borrowers to avail additional funds on top of their existing personal loan,” says Adhil Shetty, CEO, BankBazaar, a financial marketplace.

“The eligibility criteria for a top-up loan may vary between lenders and typically depend on factors such as your repayment history, credit score, and the lender's policies,” says Adhil Shetty, CEO, BankBazaar. Some lenders may also have specific criteria such as completing a certain number of EMIs before a top-up is offered.

Typically, top-up loans are available to those who have an ongoing personal loan with the lender. In many cases, the need for fresh application, documentation, and even processing fee may be waived off.

“Once this becomes available the borrowers can anytime choose to avail the extra credit without needing any extra documentation. This adds a lot of convenience and also incentivises the borrower to maintain a good repayment history as they can avail a top-up loan again after completing the given repayment duration,” says Ameet Venkeshwar, chief business officer, LoanTap, a personal loan provider.

So, while getting a personal loan is a fast and easy process, getting a top-up personal loan is even faster and easier.

Top-up home loans

The mechanism of top-up home loans is relatively straightforward. Once a borrower has successfully repaid a significant portion of their existing home loan and built up some equity in their property, they become eligible for a top-up loan.

“The top-up loan is an additional loan amount sanctioned by the lender, typically at a slightly higher interest rate than the original home loan,” says Atul Monga, CEO and Co-Founder, Basic Home loans.

The repayment tenure for a top-up loan can be similar to that of the existing home loan, and the borrower needs to make regular monthly payments.

A top-up home loan has several advantages. One of the key benefits of top-up home loans is the flexibility they offer in utilising the additional funds.

“Borrowers can use the money for a variety of purposes, including home improvements, financing their child's education, or even consolidating high-interest debts,” says Monga.

Top-up personal loan: What you need to be wary of

As far as taking a top-up personal loan is concerned, one should always be wary of the applicable rate of interest, the processing fee and any other charges associated with the loan.

There can be instances when a bank may charge a higher rate of interest on a top-up personal loan as it continues to remain an unsecured facility and a top-up increases your credit dependence.

“As a borrower, you should always consider your repaying capacity before taking a top-up personal loan as repayments for the same are set to begin from the following month,” says Raj Khosla, founder, MyMoneyMantra, a loan aggregator.

Hence one should try and avoid a top-up personal loan, as far as possible. “Taking a top-up loan means that your debt burden increases instead of decreasing over time. Unless utilised carefully and with discretion, top-up loans come with a chance of falling into a debt trap,” warns Shetty.

In other words, if you have taken a personal loan to get over financial difficulties and are already finding it tough to pay the EMIs, a top-up loan would make it worse.

Top-up home loans: The risks

Top-up home loans are considered a slightly better option in case one is in need of funds. The logic offered is that since the loan is secured against the property, the interest rates tend to be lower compared to other unsecured loans, making it a cost-effective option for those in need of extra funds.

“If you are looking for a loan but don’t have a collateral to offer to the lender, a top-up loan can unlock the unutilised or accumulated equity value of your mortgaged property at very attractive terms,” says Shetty.

It may also be difficult to pay a huge EMI on another loan product like a personal loan which does not allow an extended repayment facility along with an existing home loan. So, a top-up loan can be useful for such a borrower with a very long repayment period.

However, there are a few things one should consider. While the interest rate on a top up on your home loan is much lower, however, the repayment tenor is very long. This means that the interest outflow on your loan also will be quite high.

“If you are seeking a higher loan, you should always try negotiating the terms of loan with the lender as banks don’t want to lose a repeat customer who can bring further business for a longer duration,” says Khosla.

Also borrowers should always check the applicable rate of interest on a top-up home loan before starting afresh as low-to-moderate changes in the credit score during the course of repayment can meaningfully deviate the rate of interest for credit in the future.