Is structuring your loan really that important? Or is it a sales tactic for mortgage brokers and bankers to get in your ear and give you their advice. The answer is that it is important, mainly for your own benefit.
The 4 points below will cover off some of the structuring lessons I have seen over the past 13 years as a finance broker.
The Tax deductibility of a loan is determined by the purpose of the loan. If you have an investment property with equity and you want to borrow against the equity as a new loan to pay down your home loan – the loan is not tax deductible. It doesn’t not matter that the loan was secured by an investment property – it only matters what the purpose of the loan is for.
Fixed vs Variable
Neither is wrong, depending on why you made the decision. I once had a client lock in at a high fixed interest rate and then they dropped. The Great Financial Crisis hit in areas that finance commentators had not predicted. The client was left with a high interest rate. Naturally he was disappointed with this. When he came to me for advice, it was to get a loan approved. It was not to ask me to look into my crystal ball and look into the future and predict the future for him.
However what he did tell me was that he had a young child and his partner was expecting their second, so they couldn’t afford an increase in their monthly expenses, but they wanted to stop renting and buy a property. As such we locked in the interest rate.In hindsight he would have been better off variable. However his decision was made on the circumstances of the time.
Don’t try and pick the bottom of the market. Make the decisions on your loan based on your own personal circumstances and sound advice.
Consider hedging your bets and taking a loan that is half fixed and half variable. If rates go up, your fixed rate wins while your variable rate loses. If rates go down, vice versa, so either way you win and you lose.
An offset account is in my opinion the best type of mortgage – however make sure the offset account is “genuine”. An offset account uses the balance of your money in your day to day banking to offset the balance of your debt. The interest is calculated on the difference.
Other than saving on interest, another benefit is the tax of the savings. Rather than being taxed on interest earned in a savings account, you don’t pay interest on your money and therefore are not taxed.
Offset accounts vary greatly, and if you don’t have more than $10K at the end of the day sitting in a bank account, then it might not be for you. Generally you will pay more for a loan with an offset account, than a basic loan – so make sure you have the cash to use to your advantage.
Line of Credit
A line of credit is an offset account in reverse. Rather than using your cash – you are using credit. On paper,Line of Credit’s are a great invention – they were sold as the “pay off your home in 7 years” in the 2000’s. Never have I met a person who solely used a Line of Credit to pay off their loan in 7 years. Rarely have I met a client who has used a Line of Credit to their own advantage. A line of Credit is great for an astute investor, a mature client, or a residentially geared investment facility.
The correct structure is essential and good advice is worth considering before putting together your home loan.
Written by, Scott Matthews is the Managing Director of Finance Life, a leading Australian finance broking company.