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Principal & Interest loans and Interest Only loans?

Principal & Interest loans and Interest Only loans?

Which one should you choose?

Some of the reasons why you would choose an Interest Only (I/O) loan instead of Principal & Interest.

Why would I choose an Interest Only loan instead of Principal & Interest?

There are actually several reasons why you would want to just pay the interest on your loan rather than paying it down, however different methods are more appropriate for different people and different scenarios. Here are a few of the most common rules regarding how to manage your loan:

Cash Flow & Flexibility

Most people have heard the saying, “cash is king”.

If you have any amount of debt, especially if it is substantial, you want to have the greatest amount of flexibility available to you. In this situation, being locked into constant high repayments can – in rare situations – be a massive burden to you.

Imagine if something went a little bit wrong and you found yourself in a bit of a tight situation for a month or two (let’s say due to sickness or an unexpected large expense) your loan is going to really bite, especially if a reasonable proportion of your loan repayments are going towards paying off the loan as well as looking after the interest. In this situation, if you were to have an interest only loan, you would be able to contact your bank, bring your monthly repayments back to just the interest while you are recovering and then put them back up to whatever you wanted them to once you feel that your cash flow can handle it.

It’s very easy to do, and it gives you the breathing space to manage your affairs a lot better than if you were locked into more restrictive credit contracts.

Interest Only Loan Tax Reason #1

You have multiple reasons for wanting an Interest Only loan when it comes to tax. The first is again down to flexibility and is founded in the very foundation of tax law. The ATO is more interested in what you do with the money that you claim as deductable than where that money is from. So if you have an investment property, the fact that the money was used to buy that property is more important than the fact that you may have used your home as security to buy it. If you only have your home and no other borrowings, this will come into play if you decide to rent your property out in the future.

If you have an investment loan that is receiving Principal & Interest repayments, your debt is obviously going down. The great thing about this is that if you need to get your hands on some money, you’ve been building up a buffer by paying down you debt.

The downside is that if you use any of that buffer to buy something that is not income generating (such as a car, holiday or renovation on your own home) then the interest that you have to pay on the money that pulled out is no longer tax deductable. Why is that? You’ve just borrowed money to buy something that is not income producing. Had you been paying Interest Only on your loans, you could direct all your spare money to an offset account. An offset account is a normal bank account that a bank may give you which is linked to your loan account, but is not part of your loan account.

Every dollar that you put in the offset account is a dollar that the bank will take off your debt when calculating how much interest you have to pay. As an example, if you owed $600,000 and have $200,000 in an offset account, the bank is only going to charge interest on $400,000, even though the loan balance is still actually $600,000. If you wanted to take out some of you savings and like before spend it on something that is not tax deductable (because it does not generate an income) then you’re not actually borrowing any money – you’re taking it out of your bank account.

You’ll be paying more interest since you’ll have less in your offset account, but because you didn’t actually borrow the money, the ATO will deem the nature of the debt to still be for investment and you’ll be able to claim the lot of it as a deduction.

Interest Only Loan Tax Reason #2

The other reason is a matter of efficiency and value. If you are claiming the loan as being deductible, then you can assume that the ATO is effectively subsidising the cost of you debt. Using some basic numbers: $100,000 loan @ 10% = $10,000 interest If the loan was for investment purposes, then the $10,000 interest is tax deductable. If you’re on a marginal tax rate of 40%, when you do your tax return you’ll be entitle to get back $4,000 from the ATO. Therefore, the net amount of interest is: $10,000 – $4,000 (tax return) = $6,000. As a result of this, we can work out our after tax net rate of interest: $6,000 (net interest) on a $100,000 debt = 6% after tax rate of interest.

Using this formula with today’s interest rates, if you’re paying your bank 6.5% interest on your loan, your after tax net rate of interest is actually 3.9%. That is pretty cheap money. Now ask yourself this – if someone lent you money at 3.9% – would you want to pay it back, or would you use what money you had to investment and aim for a higher net return?

Depending on the level of risk you feel comfortable with, the answer might be very clear now as to what is the best thing for you to be doing. A lot of people say you should pay Interest Only your loans because it keeps your tax deductions high. Tax deduction is another word for expense that the Tax Act allows you to claim as an offset to income.

You would want to pay Interest Only on your loan because – after tax – there may be more efficient things you could be doing with the money.

New Taxi Payment Competitor

Taxi Payment SystemAn Aussie Price Comparison Startup HAGOOLE™ Introducing Competition to the Taxi Industry
Summary: The first taxi payment solution that empowers the Taxi Driver to negotiate on the 10% EFTPOS service charge plus it lets consumers run a virtual taxi meter to make sure they are not being ripped off.

ChargeLess™ Taxi Cash Register is a practical and efficient application which details and calculates the TOTAL taxi fare, including all relevant charges associated with a particular fare, such as the many tolls and eftpos service fees. More importantly if you are a taxi driver or operator and combine this application with a standard business (eftpos terminal) it will make you thousands of dollars!!

Features:
- Easily calculate the total taxi fare, including all tolls, charges and the service fee
- Record values of tolls and charges for future use
- Be transparent before you customer by performing calculations in front of them
- Email or print a detailed Tax Invoice (receipt) generated by the app
- Enter the total taxi fare into your own independent third party eftpos terminal and pocket the majority of the service fee
- Win regular customers by giving them a discount on the service fee charged

See screenshots of Taxi Payment App Below:

Source: Taxi Payment System

Finance Industry Transformation

StartupsDigital communications have given birth to a new generation of finance companies (see article). Money-transfer agents such as Xoom have drastically cut the time and costs for migrant workers to send money home. Peer-to-peer lenders are matching savers and borrowers, slashing fees and delivering a better deal to both. New foreign-exchange firms are giving travellers access to the prices quoted on wholesale currency markets. Card companies such as Square and iZettle let anyone from yoga teachers to plumbers accept payments by credit card. Firms such as M-Pesa have given millions of people in developing countries access to mobile money.

Creating a financial-tech company is arduous. Whereas it takes less than a day to register a company in Britain, it takes months or years and can cost millions to get authorised as a bank. The number of new banks started over the past decade can almost be counted on one hand.

Source: Economist

Minimising your mortgage

Bid Home LoansFor most of us, paying off a home loan as quickly as possible is the smartest strategy to get ahead financially.

Structuring your home loan more efficiently can help you reduce your loan balance substantially and pay off your loan faster. Mortgage minimisation is based on good planning and tight budgeting.

Increase your loan repayments

It might seem obvious, but the best way to reduce your mortgage is to simply increase your repayments. The simplest and most effective way to do this is to increase your regular repayment amount.

Some other strategies to consider are:

• Paying fortnightly instead of monthly. There are 26 fortnights in a year but only 12 months, so by dividing your set monthly repayment in two and paying it fortnightly, you will be making one additional month’s mortgage repayment each year.

• Making extra repayments whenever you can.

• Keeping your repayments the same if interest rates drop at any time.

• Next time you get a pay rise, put 50% of it towards upping your loan repayments.

Get the right home loan

Making sure that you have the right loan to suit your individual situation is important, and your Australian Mortgage Centre Broker will help you choose a loan that you are likely to be able to pay off faster.

There are many loan products that offer flexibility – for example professional packs, line of credit loans, or standard variable loans with a redraw facility, or an offset account.

Make every cent work

100 per cent offset accounts enable you to have every cent of your money working to reduce your mortgage rather than sitting idly in your cheque or savings account. Line of credit loans can achieve the same result but can be more difficult to manage as they are like giant credit cards and require great budgetary discipline from you for them to work effectively.

Consolidate your debts

You can make significant savings in interest by consolidating all your loans – personal, car and credit cards – under your home loan, where the interest is usually at a much lower rate.

Remember, however, that putting short-term consumables under long-term finance can prove expensive in the long run.

Fixed or Variable Loans – Which One to Choose?

Fixed or Variable Home LoansDo you apply for a variable rate or a fixed rate loan – perhaps both…?

The toughest loan decision of all: whether to lock in an interest rate. A fixed rate gives you security, but a variable rate can add to your flexibility and cut your costs.

As you begin looking for a home loan, you’ll come across two main types of loans: fixed and variable. Which one you choose depends on your finances, the features you need in a loan, how long you plan to own the property and whether you believe interest rates will rise or fall. The good news is that as competition has intensified, the gap between fixed and variable rates has all but disappeared.

A fixed rate home loan is taken out for a set period with a set interest rate; when this period ends you can fix the rate again, or switch to a variable interest rate which fluctuates with the market.

Variable and fixed rate loans are more or less appropriate in different financial environments, and for different types of lender.


Fixed or Variable Loans – Which One to Choose?


Fixed Home Loan Products

With fixed interest loans, the rate is set for a specific period – usually 1 to 5 years. At the end of that time, the loan reverts to a variable rate or you can renegotiate a further fixed term. By locking in your home loan, you are protected against rising interest rates. And your monthly repayments remain the same throughout the fixed-interest period.

On the down side, fixed loans have fewer features than variable loans, are expensive to break and can attract a slightly higher interest rate.

Ask yourself:

  • Do you need predictable repayments?
  • Do you anticipate any major changes to your family arrangements, job or business?
  • Do you believe rates will rise in the near future?
  • Are you buying an investment or owner-occupier property?
  • If you answered yes to most or all of these questions, a fixed rate loan may suit.

Fact: Fixed rate loans offer security and predictable repayments. But beware: breaking the loan early can cost thousands in what lenders describe as economic breakout cost fee.

Standard Variable Home Loan Product

Most standard variable loans feature accelerated repayment options, offset, redraw, split loan capacity, variable repayment schedules and portability. If you don’t plan to use most of these features, you are paying for window dressing and may be better off with a basic or fixed loan.

Disadvantages:

  • Rates can rise or fall at any stage
  • Very sensitive to economic conditions
  • Picking the next move in interest rates is very difficult


Advantages:

  • Very flexible
  • The most popular form of loan
  • Competition between banks is intense so the spread of rates is small
  • Big savings when rates low


Decide what’s important to you:

  • Redraw facility
  • Extra repayments
  • Portability
  • Flexible payments
  • All-in-one facility
  • Split loan option
  • Offset account
  • Loyalty discount
  • Top-up

Let the Australian Mortgage Centre find you the right Loan to suit your needs.

 

Article Source: Homeloans

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