You’re looking to buy a car using a bank loan. You already have an existing home loan with your bank that you have been aggressively prepaying over the years. Your bank app tempts you with a customized top-up loan offer with instant approval and 24-hour disbursal. Should you use it to finance your car purchase? Let’s break down the differences between the top-up loan and car loan to help you decide which one is right for your situation.
What Is a Top-up Loan?
A top-up loan is an additional amount borrowed on top of an existing loan, such as a home loan. If you already have an ongoing loan with a good repayment history, you might be eligible for a top-up loan to finance your car purchase. Your property would serve as a collateral for the home top-up loan.
Related Reading: Top Up Loan Is a Cheaper & Better Alternative to Personal Loan
What Are the Advantages of a Top-up Loan?
- Quick disbursal: Top-up loans are often processed faster than traditional car loans. Documentation required would be few because the bank already has your verified KYC, income and collateral details from the existing home loan. Your past payment record with the bank (combined with the credit score) would determine your eligibility. No additional collateral is required, as the top-up loan is approved based on an existing loan.
- Potential lower interest rates: Depending on your existing loan’s interest rate, a top-up loan might offer a lower rate compared to a dedicated car loan. The difference in interest rates would be even more stark when compared to pre-owned (used) car loans. Pre-owned car loans often come with higher interest rates because used cars are viewed as riskier investments. Factors contributing to this perception include potential maintenance issues, uncertain vehicle history, and faster depreciation.
- Longer Tenure: Top-up loan can have longer tenure whereas a car loan typically has a maximum tenure of 7 years. This results in lower EMI and higher eligibility.
- Flexibility: You can use a portion of the top-up loan amount for other purposes besides a car purchase, if needed. Like going on a long vacation with your family in your new car.
- No prepayment penalties: Generally, a top-up loan is a floating rate loan whereas a car loan is a fixed-rate loan. So you could prepay and preclosure the top-up loan without incurring penalties. However, some public sector banks (SBI is an exception) tend to offer floating rate car loans.
What Are the Disadvantages or Pitfalls of a Top-up Loan?
- Don’t choose a car based on the size of the loan amount. Just because the same Rs 25k monthly EMI can service a 5-year-9% ROI-Rs 12L car loan OR a 10-year-9% ROI-Rs 20L top-up loan, you shouldn’t opt for the latter. The higher top-up loan amount (with a longer tenure) shouldn’t tempt you to purchase a swanky high-end car even if it fits your monthly budget. Always follow the 20-10-4 Rule.
- Consider your future car purchases. A top-up loan’s repayment tenure is typically longer than the average car ownership period. This means you might still be paying off your loan when it’s time to buy a new one. This could strain your budget and potentially limit your options for financing your next vehicle.
- You could lose your home (instead of a car) in case of a default. The bank will sell your property (collateral) in case you default on the loan. Most people would rather lose a much depreciated car than lose a home during tough times. Not that you should be planning for such eventuality, but you should be aware of the differences.
- Consider the tax benefits. Self-employed individuals or business owners can avail of tax benefits on the interest payment of the car loan if the vehicle is purchased for business purposes. They can also claim tax benefits on the depreciation of the car. This can be difficult to show on a top-up loan. Please check with your chartered accountant for more on this aspect.
Consider Flexible Car Loans Too
If you are concerned about EMI affordability, then you could also explore flexible car loans. Usually, the flexibility translates to lower EMIs upfront or some concessions during the loan tenure.