Its that time of year again!
Do you fancy an interest and tax honeymoon?
Newsletter 2003

At this time of year, every investor should be asking whether or not they can benefit from interest in advance lending. Taking into account our rebate, a $300,000 loan through Peach would enjoy an interest only ‘honeymoon’ rate of 5.19% in the first year, without any penalties for exit in the next year.

If you want to pull forward your tax deductions then let us know by filling in the form below – and by reading on.

An investor who pays next year’s interest on their loan in advance this financial year can generally use any allowable interest deduction to reduce their taxable income this financial year.

This pull forward of your tax refund can be very useful as it effectively allows you to claim two years' deductions in one year. Remember that most of your savings from interest only in advance (IOA) lending are from the pull forward of tax refunds - the total amount of your tax refund will generally stay about the same but you'll get it sooner, so you'll get a free loan from the Government. Against this you pay interest earlier so you'll incur your expenses sooner as well. But the payment happens just before the end of the financial year and the benefits arrive at the beginning of the next, Our calculations suggest that, even without specific advantages set out below, this usually provides net benefits when one allows for the timing of the cash flows in and out of your account. Nevertheless you need to balance the benefits against the costs in each individual case.

Of course you can keep doing this in future years - so that instead of claiming two years’ interest this year and no interest next year, you can pull forward interest payments again next year and each year after that. The 'loan' from the government can stretch out a long time and you can end up a fair way ahead.

Note in addition that if you happen to earn less in one financial year than others, especially if this moves you to a lower marginal tax rate, that's the year you should use to effectively have an 'interest pause'. You might plan this as an extended holiday with some leave without pay or as a break between jobs. Or you might think that part of the benefit of paying interest only in advance is that you have prepared for a period of involuntary unemployment between jobs. It's something most people can’t rule out these days.

The lower deductions will be worth less to you when you're on a lower marginal rate and if you're taking home less money you'll be glad for the additional cash in that year. We're working on a calculator that will help you decide how the financial equation works out for you.

Interest in advance also raises the issue of fixed interest lending. That’s because to pay interest in advance you have to fix for at least the period for which you will be paying interest in advance. In fact you can fix for longer periods and pay interest in advance - and with the right lender the rate is a little lower by around 0.1% or 0.2% for all possible terms of fixing. This means that, with fixed rates as low as they are, you can lock in the benefits of interest only in advance for many years to come. (Note, while you can pay for longer periods than a year interest in advance, there is little or no tax advantage in doing so as tax law limits the benefits of doing so.)

We have discussed the downsides to fixing in earlier newsletters but our most recent newsletter on the subject suggested that, at least for those who should be considering fixing, now is a pretty good time to fix.

To recapitulate, fixing is worthwhile if you're the cautious type - you're just financially conservative and you want peace of mind. Paradoxically, it also makes sense for some people with the opposite temperament - namely those seeking to borrow and invest as much as they can. For such people, particularly where they do not have strong income from other sources, fixing could prevent them getting caught in a credit squeeze with rising interest rates forcing them to sell their properties at the worst possible time - when others are being forced to do the same.

And because fixing lowers risk, it has an additional benefit for people wanting to gear up and invest. Where serviceability is a problem and fixed rates are sufficiently low - as they are now - some lenders can calculate a borrower's capacity to service a loan at the actual interest rate they'll be paying, rather than the variable rate plus a margin to allow for the possibility of subsequent interest rate rises. This margin is usually around 2% and sometimes more. So when fixed rates are not much higher than variable rates - as is the case today - this stretches the capacity to service a loan into the future and lenders are prepared to lend more – sometimes a lot more – because the loan is so much less risky.

Remember if you are interested, don't delay. It often takes lenders up to two months to settle a loan - especially if a refinance is involved and the incumbent lender drags its feet in facilitating settlement. If you want to move quickly just fill out the summary details at the top of this newsletter and send them to us.

Cheers,


AKA Nicholas Gruen
May 2003

Please note: The observations made here are general and indicative.Nicholas Gruen is not a qualified investment adviser. Further his comments are general and do not take into account your specific circumstances. Nor are they warranted as free from error in any respect whatsoever. You should not rely on any aspect of them without taking independent financial advice relating to your own specific circumstances. We suggest you obtain advice on a fee for service basis rather than from someone who earns either up-front or trailing commissions from investments they recommend. We would be happy to let you know of service providers who provide advice on this basis.