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There are several ways you can finance large personal purchases, but with historically low home loan interest rates, a top up loan on your existing home loan could be the most cost-effective option.
What is a top up loan?
A top up loan is a loan that is added to your existing home loan. Your home loan balance is the only thing that changes, and your loan repayments will be recalculated to pay the new balance off within the existing loan term.
Because you are borrowing more money, your lender will need to consider two key criteria when assessing your application.
A lender will usually lend up to 80% loan to value ratio (LVR) of a property when using home loan funds for purposes other than buying a home. This includes existing borrowings secured by the home and the proposed top up loan. They may require a valuation on your property to determine its current value and to see if the top up request fits within the available equity.
Property value $500,000
80% of property value $400,000
Existing home loan $350,000
Available for top up $50,000
- Useful reading: What does loan to value ratio (LVR) mean?
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A responsible lender will ensure the increased loan amount won’t cause you financial stress. They will do this by calculating your serviceability based on your income available to meet all debts, ongoing financial commitments and living expenses. If your circumstances have changed since you first obtained your home loan (lower incomes/higher expenses), the top up loan may not get approved.
Both equity and serviceability need to stack up for the green light.
- Useful reading: What you need to know about home loan serviceability
What can I buy with a top up loan?
Top up loans can be used for most personal purposes.
- Home improvements and renovations
- Motor vehicles
- Leisure craft such as boats or jet-skis
- Debt consolidation
- Education expenses
Benefits of topping up your home loan
- You’ll have one payment that is convenient and easier to manage.
- It can help with affordability if budgets are tight.
- Applying through your current bank may be quicker and easier than approaching a new financier.
- Interest rates may be lower than other finance options.
- Most loan types will allow you to make extra repayments without penalty to pay off the top up portion sooner.
What’s the downside to using a top up loan?
- Your monthly mortgage repayments will increase.
- Repayments for the top up amount will be calculated over the remaining loan term (which could be up to 30 years).
- Interest over the longer term outweighs the benefits of a lower interest rate.
- You may have to pay a fee to top up your loan.
- There may be a minimum amount required for top up loans.
- Some home loans aren’t eligible for top ups like fixed rate loans.
Using a disciplined approach to paying off your top up loan
Top up loans can be an affordable way to borrow for personal reasons. But to get the full benefit of the low interest rate, you need to repay the top up portion within a reduced time frame. The time frame will be dependent on the type of purchase you’ve made. For example – a car loan is usually fully repaid within 5 – 7 years. But a holiday should be paid off in a shorter time frame. Calculating what your repayment would be if you used an alternative finance option (and making those repayments to your home loan) will ensure your top up is repaid long before your home loan term ends.
You should seek advice from your accountant if you’re considering using a top up for investment purposes. These types of loans should be kept separate from home loan borrowings, so it’s easier to calculate and report deductions for tax concessions.
And if you decide to turn your home into an investment property down the track – you’ll need to apportion the existing home loan balance because you can only claim interest charged on the loan balance that was used to purchase the home.
We can help you buy more than houses. Find out if a top up loan is suitable for you. Have a chat to your Yellow Brick Road mortgage broker to find out what your options are.