In this article Julia Hartman, the Founder of BAN TACS – National Accountants Group explains how in a low interest rate environment a one percent reduction in your interest rate could reduce the amount of interest you pay by 20%.
Back when interest rates were high and banks weren’t that concerned whether you were borrowing for your own home or an investment property it was a no brainer to pay interest only on your investment loan and concentrate all your spare funds into paying off the loan on your owner occupied residence. Not any more, it now warrants careful consideration of your circumstances.
Don’t spend a dollar just because it is tax deductible, consider that the Australian Taxation Office (ATO) only gives you around 35 cents back, at the best 47 cents, for every dollar you spend on interest. You are still better to save the dollar on interest in the first place.
Check out these numbers – If switching from an interest only to a principal and interest loan can reduce your interest rate by just half a percent, that interest saving will pay off 68% of the loan principal.
Imagine the difference if you can negotiate a full 1% reduction.
Here’s an example
Assume a $700,000 loan at 5% interest only reduced to 4.5% for principal and interest.
The annual repayments would be $42,564 which is $7,564 more than the $35,000 payable on interest only.
Over 30 years that adds up to a total of $226,920 in extra repayments. But the whole $700,000 has been paid off.
The interest saving paid is $473,080, nearly half a million dollars off the loan!
Examine your own situation
To work this out for your circumstances, use this loan calculator tool to calculate what your principal and interest repayments will be.
Fixing your loan may also reduce your interest rate. The trouble with most fixed loans is they don’t allow an offset account. The trick here is to keep the portion of the loan that you expect to be able to offset, as a variable loan and just fix the rest. Of course, if you have non deductible debt the offset account should be on that anyway.
If you have available equity in your owner occupied loan see if the bank will reduce your interest rate if they hold that as security instead of an investment property. I know that involves the much maligned cross collateralisation arrangement, but let’s face it, if you default on your rental property loan and the bank can’t sell the rental property for enough to cover the loan, they are going to come after your house anyway, cross collateralisation just speeds up the process.
If this motivates you to refinance make sure that you are very careful to keep the nexus between the original borrowings and the new loan. There can’t be any detours along the way. You need to have bank statements showing the drawing down of the new loan going directly to paying out the old loan. If you are going to borrow for something else as well, set it up in a separate loan.
If after having read this you are thinking about amending your loan structure(s) you might like to speak to one of our friendly experts, we would be happy to help you. Call 1300 888 299 or send us an email.
Julia Hartman is the founder of the BAN TACS National Accountants Group which has offices on the east and south coast of Australia, from Mackay to Adelaide. You can visit Julia’s website to learn more or ask Julia a question by going to her online forum.
General Advice Warning: This blog is not designed to replace professional advice. It has been prepared without taking into account your objectives, financial situation or needs. You should consider the appropriateness of the advice, in light of your own objectives, financial situation or needs before making any decision as to what is appropriate for you.