Paying Interest in Advance - a quick decision needed!

With the end of the financial year rapidly approaching, now is the time for property investors to consider whether they should pay next year’s loan interest in advance.

The advantage of paying all the interest due in 2005/2005 in advance is that that you can claim the deductions in this financial year. So, on top of this year’s refund, you’ll get also next year’s refund a year early.

This pull-forward of a tax refund allows you to effectively claim two years’ deductions in one year. The total amount of tax refunds will generally stay the same, but you’ll get them sooner. In effect, it’s a free loan from the government.

You can keep doing this in future years - 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.

The other benefit is that it allows you to reduce your risk as interest only in advance loans are effectively fixed for the year you pay them (otherwise how could you work out how much interest to pay in advance?!)

Paying interest in advance can be particularly advantageous if the investor happens to earn less in one future financial year than others. That year could be used for an "interest pause", especially if the individual moves to a lower marginal tax rate.

So the decision to pay interest in advance could effectively save you thousands. For instance, take a loan we organised for a client around this time last year. The client was borrowing $420,000. This year she would have paid around $27,500 in interest. Instead she paid it before the 30 June last financial year. (Actually it was a little less, as most lenders offer discounts for up front payment as they get their money sooner).

This way she not only got a small discount off the one year fixed rate available now, she declared the income last financial year. Her tax refund was over $13,000 more last year. That's an interest free loan from the tax office for 12 months.

There are potential downsides to also consider. You’ll pay your interest earlier, so you incur your expenses as well as the benefits sooner. Also fixing lowers risk, but risk isn’t all bad. There’s upside risk and downside risk. Its possible you’ll fix for the next year only to find rates fall during that year. I think that’s a possibility, though its hard to see rates falling by very much - ie by more than .5% and most economists think the next move will be up (I disagree but we’re all just making more and less educated guesses!) Therefore each individual investor needs to balance the benefits against the costs.

Have a think about whether this is for you. If so, you need to move NOW! We are two months away from the end of the financial year but lenders can be slow in settling loans, particularly if refinances are necessary, and for some reason best known to them, lenders typically require all interest in advance lending to be settled a week or two BEFORE the end of the financial year.

Most home loans don't allow for interest in advance, so you should contact us soon.

We've been scanning the market for the most competitive interest in advance loans, so you can pick our brains. And if you want to proceed to refinance your loan through Peach, you can pick our pockets too. Our normal rebates still apply - $1,000 or more for most many loans over $300,000 and generous rebates for loans from $150,000.

(Information in this newsletter is of a general nature. Individuals should seek professional tax and investment advice to check plans against their specific circumstances.)

Cheers,


AKA Nicholas Gruen