A top-up mortgage is a home loan that allows homeowners to borrow more money by accessing the equity they’ve built in their home.
Also known as a home loan top up, a top-up mortgage is a popular means of accessing credit – partly because it offers a cheaper supply of credit than credit cards and other unsecured loans, and partly because it eliminates the need for borrowers to apply for a separate loan, meaning they can avoid undergoing a credit checking process with another lender.
But while it’s often a practical means of accessing credit, it involves significantly increasing your overall loan principal, which means you’ll be saddled with much higher monthly repayments.
Here’s what you need to know.
Why use a top-up mortgage?
Some of the most popular reasons people use top-up mortgages include:
- buying another property as a rental home investment
- funding a major renovation to their current home
- consolidating existing debts
- buying a new car or paying for a holiday.
While there are risks involved with top-up mortgages, they generally offer money at lower interest rates than credit cards and other loan types.
Who can use a top-up mortgage?
Anyone with an existing mortgage can access this type of borrowing – as long as they have sufficient equity in their principal place of residence.
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Investors can also increase the size of their loan but need to be careful about tax implications and should therefore seek professional advice first.
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How does a top-up mortgage work?
Assuming you meet their lending criteria, most banks will allow you to increase your home loan to 80% of the property’s value.
For example, let’s say four years ago you borrowed $640,000 from the bank to buy a property worth $800,000, and that you’ve now paid $100,000 off your home loan and the property’s value has increased to $900,000.
This would mean that the outstanding balance of your home loan currently sits at $540,000, meaning your loan-to-value ratio has been reduced to 60%. Given most banks will let you borrow up to 80% of your property’s value, you would likely be able to increase your home loan to $720,000 (80% of $900,000), meaning you could draw out $180,000 in cash ($720,000 – $540,000).
You could then use this cash to buy an investment property or fund a renovation.
However, increasing your loan size by $180,000 will significantly increase your monthly repayments, meaning you’ll take much longer to pay off your mortgage.
It’s also worth noting that not all home loans offer borrowers access to top-ups, and so you may need to discuss alternative funding options with your lender.
Provided they do, you may also need to pay an establishment fee – upwards of $300 – to set up the top-up, and a small monthly service fee to maintain it – both of which the lender will likely capitalise into your overall mortgage, resulting in even higher monthly repayments.
Things to consider before applying for a top-up mortgage
As we discussed earlier, top-up mortgages are a great way to access credit. They generally offer cheaper credit than credit cards and other unsecured loans, and eliminate the need to apply for a separate loan.
But increasing your loan principal means that it will take a lot longer to pay off your mortgage.
And so you should really drill into your reasons for applying for the top-up. If it’s to fund a holiday or a new car, then you have to ask yourself whether you want to be paying off these purchases beyond their lifetime.
Funding a renovation or an investment property purchase could be a better use of the mortgage top-up, as a renovation will likely increase the value of your home and an investment property could provide you with a sizeable income – and the income you earn from these investments could end up going towards paying off the cost of your initial home loan top-up.