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Should you prepay your home loan?
Vinita Mistry took a home loan from her friendly neighbourhood bank two years ago. She bought a cute cozy apartment in a block of 60 apartments in a community enclave, which housed 300 apartments in all. At that time she did not have a four wheeler and rode a trendy power bike to work, which was always parked under the stairway that went up to her 5th floor apartment. She eventually moved office and upgraded to a gorgeous looking small car. Then she had a problem - parking space!
She figured she needed to buy that additionally apart from her apartment cost. She wished to take a loan to cover the cost of purchasing a parking slot. How can she go about this? Are you stumped like Vinita wanting more amenities or are you looking for some urgent funds, without expensive interest rates attached to it? Well, a top up loan on your existing home loan might just be the answer. Let us understand the various nuances of a top up loan before you decide to shortlist this as an option.
How it works
A top up loan basically allows you to avail a loan amount on top of your home loan. The usual loan tenure is about 10 years and is often offered only after a few years into the home loan disbursal, as this gives a fair idea about your repayment track record, which means no defaults down the line and this also increases your loan eligibility.
The logic behind a top up loan is the fact that you have already started repaying your loan, hence your outstanding loan amount with the bank has already begun decreasing with each payment. A top up just enables you to utilize that margin towards obtaining a loan that you may urgently require to meet some of your needs.
Utilising a top up loan
Top up loans are a boon to people who are in urgent need of funds. It is almost like a personal loan, except that it comes with better interest rates though not as good as home loan rates but is based on the prevailing rack rates. You can utilise this loan for any purpose. A top up loan on your existing home loan is an ideal choice to pay for your parking space or to fund your son's higher education for instance.
You can take a top up only when you have a home loan to top up on. The conditions for top up loans vary from bank to bank. You can approach the same bank in which you took your home loan but if your bank does not offer you the option, as some reserve the right to provide a top up, then you could shift the home loan to a bank that is willing to give you a good deal on the top up loan. Keep in mind that you need to have an impeccable repayment track record.
The outstanding loan amount pending with the bank, the market value of the property and your ability to repay a top up, are all taken into account to figure out how much top up the bank gives you. In fact the upper limit on the loan amount is defined based on these three aspects. It is always ensured that the outstanding loan amount you owe the bank plus the top up loan does not increase beyond around 70 per cent of the market value of the property. Also, each bank will have its own upper limit and the loan amount will be restricted accordingly.
Tax benefits are dependent on the purpose for which the loan is utilized. For Vinita, the loan is for parking space, which is part of property acquisition. Hence, she would be eligible for a tax rebate on both the principal and tax repaid towards the top up loan capped at Rs 100,000 and Rs 150,000 respectively, which is inclusive of the rebate she would avail from her current home loan.
|A sample calculation for Vinita's top up loan|
Let us assume Vinita has taken a loan of Rs 30 lakh (Rs 3 million) at a 12 per cent interest rate for a period of 20 years and as specified is now in her third year into the loan.
Let us make another assumption that from the time she purchased the property, the value has risen by Rs 20 lakh, which pegs the current market value of the property at Rs 50 lakh.
70% of Rs 50 lakh (Rs 5 million) = Rs 35 lakh (Rs 3.5 million) (70% of the value is taken as the margin beyond which the loan will not exceed)
Next, the outstanding loan amount is deducted from the above figure:
Three years into the loan she would have repaid a principal amount of Rs 131,000
Remaining Principal amount to be repaid - Rs 28.7lakh (Rs 2.87 million)
Rs 35 lakh (70% of market value) - Rs 28.7 lakh (principal yet to be repaid) = Rs 630,000
Hence the maximum top up loan she will be eligible for based on this example, is Rs 630,000.
However, to avail a top up loan, factors like your repayment capacity based on your income and commitment towards any other loans other than your home loan etc, will be factored in before the bank decides on the exact top up loan amount they can offer you.The author is Head of Content & Research at BankBazaar.com
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