Are loan top-ups more cost-effective for you than applying for a new loan?

Dubai: Let’s say a loan you’ve taken to buy a home or a car falls short, then you may need to borrow additional money to bridge the gap. You would then have two options – either to take a top-up loan against the existing loan, or take a separate personal loan.

“A top-up loan is like a booster loan given to an existing borrower and is generally preferred over the personal loan as the interest rate is often relatively lower as compared to personal loans,” said Dubai-based banking and credit analyst Rupesh Naish.

“Moreover, considering that the lender would already have your details or documents, the processing of the loan will be faster and easier. Besides this, even the tenure for a top-up loan is longer, which can result in a lower Equated Monthly Instalment (EMI), making it a better option among the two.”

How does interest rates differ between the two?

The interest on a top-up loan is generally comparable to the interest against the original long-term loan and doesn’t need additional paperwork, but is hard to get sanctioned. On the other hand taking a personal loan may be expensive, but easier to take.

“However, not every borrower is offered a top-up loan facility. Only individuals with good payment history and good credit score can get the loan sanctioned for top-up loan,” Naish further added.

“Also, if the top-up loan is on an existing secured loan like an auto or home then it increases principal owed and thereby reduces the 'equity'. This would also mean if one is trying to sell a vehicle, purchased by taking auto loan, the borrower would have to first clear the top-up loan as well, which would not be the case if the customer had accessed a new personal loan.”

Here's an illustration of opting for top-up loans

Here’s a hypothetical case study. Let’s assume that a 35-year-old UAE-resident took a Dh6 million home loan five years ago for a tenure of 20 years, and has been consistently repaying it until now.

Now let’s say he wanted to extend a portion of his house to build an additional room and he needed additional funds of Dh500,000 to complete the task for which his only option was borrowing from banks. He has to either apply for a new personal loan, repay it in 4 years, or he can go for a top-up loan instead.

While applying for a fresh loan would involve a documentation process, fresh credit enquiry, processing fees etc, with a top-up loan, you can get immediate funding without having to go through all the processes.

But what about the interest rate when compared to a fresh loan? Let’s work out the mathematical calculation by comparing both options.

What can be inferred from the above study?

As per the above table, the borrower could save nearly Dh17,000 with the top-up loan. But keep in mind the interest rate on a personal loan could go even higher while the interest rate on a top-up loan can reduce, depending on how much loan you have already paid off and on your credit history.

However, there is also a disadvantage with the top-up loan, if the borrower wants to repay it with the remaining tenure of his home loan of 15 years. In such a scenario, you will be paying a hefty sum as interest just for the top-up loan alone in the long run, but with low EMIs. Here's how dues will rise if a borrower chooses to do so.

But in the above case study, it would be more cost-effective for the borrower to go for a top-up on the home loan with a tenure of 4 years.

How do banks calculate whether you are eligible for home loans?

You must remember than banks fund home loans based on the market value of the property. Banks lend 75-80 per cent or less of the market value of the property, if the value of the property is less than Dh5 million, while lending lesser to the borrower if the value of property is more than that.

“Banks will offer you a top-up loan only if it is possible to extend more credit within the Loan-to-Value (LTV) framework i.e. if it is 75-80 per cent of the market value of the property or less. You must also be credit worthy to bear the additional liability,” explained UAE-based debt consultant Rajesh Markara.

“Banks will calculate the top-up loan amount, after taking into account the Equated Monthly Instalment (EMI) of your running home loan. The bank will estimate the Fixed-Obligation-to-Income ratio (FOIR) for your top-up loan, which is simply deducting the instalments of all your running obligations.”

Key takeaways

The interest rates offered on top-up personal loans are similar to regular personal loans. If you find a lower rate than what is offered in the market, it makes sense to opt for the offer. Otherwise, you should negotiate with the lender on the interest rate.

With a strong repayment record and good credit score, you can negotiate with the lender on a personal loan top-up interest rate, processing fee, and other charges. However, before opting for the same, it is crucial to analyse your needs and avail of the loan only during emergencies.

“Remember that since a top-up personal loan does not let you change the loan terms, your EMI burden increases. In order to timely repay the increased EMIs, you should make sure your income has increased than what it was when you availed of the existing personal loan,” cautioned Markara.

“Finally, be mindful that any late payments or defaults on any credit agreements could lead to worse outcomes, such as bankruptcy and repossessions. Whether you are applying for a top-up or a concurrent loan, always ensure that you can comfortably make the repayments.”