We live in North Western Sydney but both work at Mascot and thinking of renting our place and living in an apartment closer to work for 12 months for a change in lifestyle. When we discussed this with some friends they suggested we should change our home loan to interest only to maximise negative gearing. Is this good advice as when we called the bank they said our interest rate would increase by 0.20%?

Hi Kym,

Any advice given must be researched well and relevant to your specific situation and circumstances.

However, there are a few things to know. You will need to speak to your accountant as well.
As your current loan is for the purpose of your owner occupied home, it can’t be simply treated as investment Debt now.

You will need to refinance and restructure you loan accordingly for any debt which will be investment debt and any debt which is purely personal debt.

APRA is discouraging interest only loans, this is why the interest rates for these loans are higher. It’s also higher again for investment loans.
You may we’ll be best to keep the loan as P+I depending on the amount, time left. Repayments etc and your income position.

There’s more than meets they eye on these types of changes hence why you should speak to a good accountant and Mortgage expert. You should also review your short term goals and objectives as well.

Also bear in mind, a small interest rate change won’t make much difference in the repayments compared with switching to interest only. Either way, the goal should remain to pay your Mortgage down ASAP - especially any bad debt.

Speak to an accountant about if negative gearing will benefit you or not - specific to your income position and relative to property title ownership.

Hi Kym, Great question.
When claiming negative gearing you are only able to claim the interest on the loan. In many cases investor will chose to have an interest only loan because as the balance remains the same over time the amount of tax deduction stays the same. Also because you not repaying the principle the loan repayments will be less, so it may help with cash flow, i.e the rental income covering the loan repayments.
If your only looking to move out for 12 months for a change of lifestyle and you can afford the current loan repayments plus the potential rental on the apartment closer to work the difference in tax deductions from one year to the next would not be significant enough to make the change to interest only worth it.
If your planning to move back in after 12 months for example or sell you may also want to leave the current loan in place since you would benefit from the loan being reduced over the 12 months.
Hope this Helps
Awesome Albert

Hi Kym,

The old way of thinking was if you have tax deductible debt was to pay that on an interest only basis so you aren't reducing your tax deductions, and utilise the extra surplus cash flow to direct to non deductible debt or other investment opportunities.

However, last year APRA imposed more restrictions on banks around interest only and investment loans which generally will make them more expensive than a standard principal and interest loan. So now, whilst it isn't always ideal to pay capital off a tax deductible loan, it generally works out best to pay principal and interest as you will pay less interest.

Obviously paying a lower interest rate is always going to be best, tax deductible or not, the down side is that you are reducing that tax deductible loan with principle payments, where you might be able to direct somewhere more tax effective. And, what are you going to do with surplus cash flow otherwise? If the answer is spend it, then you definitely are better off paying it off the loan, and if you are going to be paying it off the loan anyway (or accumulating it in an offset account), then obviously the lower interest rate is better.

Having said that though, if the loan is say in the name of someone who is on the top marginal tax rate, and the alternative is to invest in the name of someone with a 0% tax rate, then there could be a case for paying the 0.20% higher interest rate to retain interest only, then use that extra cash flow (the principal that you would otherwise be having to pay) to invest in the lower tax rate individual/entity.

If you do go P&I though, and you are going to use the cash flow for something constructive elsewhere (super contributions, paying off some other non deductible debt etc), you might want to ask the bank to go as low as possible on the principal repayment.

It's good to see you getting a second opinion though because often friends advice can often not be the best. People have old money myths that might not actually be right.

I hope all that makes sense.

Cheers

Glenn

Hey Kym,

Now that the market has both higher rates for interest only and investment loans, more thought needs to be given these days into what your ultimate strategy is for your property.

Most of my clients tell me that they want their investment property to assist in funding their retirement. To do this it means that the loan needs to be paid off one day.

For this reason, if making P&I payments doesn't hurt your budget, I'd stick with that as opposed to switching to interest only and copping a higher interest rate.

Let me know if you want to talk about this in further detail.

Kind regards,

Tim Russell

Hi Kym,

you can see above there are a number of different approaches towards this one and you may find the cornerstone points for you to consider are

1. What experieince does your firend have in dealing with tax related questions - Say if they were an accountant then perhaps their advice MAY be very well positioned as they MAY know mor about your situation than we can read from the lines you have shared.

2. YOUR accountant is the BEST person to advise you wether this is good advice and likewise able to provide you with tax advice and consider ALL of your affairs.

Of course, outside of that, the finance side of things comes down to your motivation to do this (outside of lifestyle) , as in what would be an ideal outcome for you financially if you were to do this? perhaps it is as simple as having extra cashflow, , minimising tax or something else?

Good luck with your exciting change of lifestyle and enjoy the extra few hours sleep in!

Regards

Craig